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5 Steps to Deciphering Past Performance

Trailing returns are commonly used when assessing a fund but can often be misleading; here's how to unearth a fund's more realistic potential

Christine Benz 07.02.2014

Is it any wonder so many investors are confused? After all, so much about investing is counterintuitive: The stock of a company frequently goes up when the firm lays people off, bond prices go down when yields rise, and low fund costs tend to predict better performance.

An even bigger head-scratcher is that past performance — just because a fund has shiny top-percentile rankings during every time period, the data suggest that it's unlikely to be able to maintain that performance edge going forward.

The most recent research on the "is past performance predictive?" question appeared in the June/July issue of MorningstarAdvisor. Using top-quartile funds within several of Morningstar's diversified US-equity-fund categories, Morningstar Investment Services' president and CIO Jeff Ptak examined how the funds performed during subsequent five-year periods. He found that, depending on the category, just 10%-20% of the top-quartile funds remained in the top quartile of their peer groups in the future five-year periods. He also concluded that "you were likelier to find a top-quartile fund in a category's bottom half than its top half."

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About Author

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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