By Michael Foster, CFA, CFP®
Choosing a fund to invest in can feel like going to the world’s largest supermarket without a shopping list. There are all sorts of different types with different objectives across different markets run by different people at different companies…I think you get the point. In fact, there were over 4,700 different equity and fixed income funds domiciled in the US as of the end of 20221. So how do you choose the right fund(s) to invest in?
For many investors, recent performance is often a starting point. After all, who doesn’t want to make the most money in their investments? With the rise in online research platforms and screeners, it’s never been easier to simply look for the best performing funds. Individuals can use Morningstar, Zacks, Yahoo Finance, and a host of other tools to quickly filter out what’s done well lately. Overall, I think these tools are great for investors. More information available to more people is a good thing! Despite this, I don’t feel that short-term performance should be the primary determinant in choosing an investment.
Screening for short-term performance isn’t guaranteed, or even necessarily likely to produce a better investment return in the following period. What’s done well lately doesn’t seem to correlate with what’s likely to do well now. Take the chart below as an example. It shows how the top quarter of equity funds within their category over the previous 5 years performed over the subsequent 5 years. What you see is that, on average, only about 22% that started in the top quarter also ended in the top quarter over the next 5 years. That’s right around the 25% number you’d expect by random chance alone. Simply picking recent winners may not be a sound investment philosophy.
Source: Dimensional Fund Advisors
Having a clear, consistent investment philosophy can help investors distill the fund landscape down to a more reasonable number of options. If you know you want to have low-cost, broadly diversified options that are rooted in insights from years of financial research, the universe becomes much more manageable. For us, it’s about using the best information available to make the most informed decision for the long-term. While strong short-term performance is always desired, it may not be the best way to structure a long-term portfolio.
1 Source: Dimensional Fund Advisors, “The Fund Landscape”
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data are historical and are no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.Nothing in this material should be construed as investment advice offered by Dolan Capital Advisors, Inc. This market commentary is for informational purposes only and is not meant to constitute a recommendation of any particular investment, security, portfolio of securities, transaction, or investment strategy. No chart, graph, or other figure provided should be used to determine which securities to buy, sell or hold. No representation is made concerning the appropriateness of any particular investment, security, portfolio of securities, transaction, or investment strategy. You should speak with your own financial professional before making any investment decisions. Past performance is not indicative of future results. Dolan Capital Advisors, Inc. does not guarantee any specific outcome or profit. These disclosures cannot and do not list every conceivable factor that may affect the results of any investment or investment strategy. Risks will arise, and an investor must be willing and able to accept those risks, including the loss of principal. Certain statements contained herein are statements of future expectations and other forward-looking statements that are based on opinions and assumptions that involve known and unknown risks and uncertainties that would cause actual results, performance, or events to differ materially from those expressed or implied in such statements. Ben Dolan and Michael Foster are investment advisor representatives of Dolan Capital Advisors a North Carolina state-registered investment adviser. Investment advice offered through Dolan Capital Advisors, Inc.