In most endeavors, there are things you can control and things you can't. That's true in life. That's true in business. That's true with investing. The good news about investing is that markets have rewarded investors over the long term. But over the short term—as anyone who has paid attention to markets knows—markets go up and markets go down. I thought it would be helpful to share some observations about the investment business and what it takes to have a good experience.
Few things have been studied as extensively as the performance of professionally managed funds. While the results indicate that some managers have good track records, there are far fewer of them than you would expect by chance.
What does that mean to investors? It means that even after analyzing all the data, you can’t separate skilled money managers from lucky ones. And if you can’t identify superior managers after the fact, how can you identify them in advance? Based on the overwhelming evidence, there is no magic to investing.
The data shown here is derived from the CRSP Survivorship-Bias-Free Mutual Fund Database and Ken French's data library. Methodology based on Fama and French (2010). Please see disclosure in Appendix for important information regarding bootstrapped simulations and methodology details. Fama, Eugene F., and Kenneth R. French. 2010. "Luck versus Skill in the Cross-Section of Mutual Fund Returns." The Journal of Finance 65(5) (2010): 1915-1947. Meyer-Brauns, Philipp. 2016. "Mutual Fund Performance through a Five-Factor Lens." Dimensional Fund Advisors. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
Throughout their lives, people must continually deal with uncertainty and make choices—what school to attend, what career to pursue, where to live, and so forth. You make these decisions without knowing the outcomes. You look at all the possibilities, and then you decide.
Much of the financial services industry is geared toward making people think they can eliminate uncertainty in investing. However, the future is unknowable. The best approach to dealing with uncertainty is to make informed choices, adjust as your needs and objectives change, and be comfortable with the range of possible outcomes.
The sample includes funds at the beginning of the 15-year period ending December 31, 2017. Survivors are funds that had returns for every month in the sample period. Winners are funds that survived and outperformed their respective Morningstar category benchmark over the period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Past performance is no guarantee of future results. See Appendix for more information.
A philosophy serves as a compass to guide you through turbulent times. When you’ve got a compass, it doesn’t take drastic directional changes to find your way. Small adjustments are all you need to stay on course.
In 2009, the US stock market was down more than 50%, which seems to happen about once every generation. A lot of people were stressed out by the uncertainty, so they cashed out. That locked in their losses. The market, as it turned out, rebounded and some of those people who got out of the market may have to wait decades to get back to where they were. It’s unfortunate they didn’t stick it out so that they could have better weathered the storm.
Past performance is not a guarantee of future results. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual fund. S&P 500 Index (Total Return) data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Trust involves many different parts. To trust markets, you must understand how they work, which means having a source of reliable knowledge. The best source is scientific research, not opinions and hunches. You must also trust the professionals who are managing your investments, which should involve a clear understanding of what services and expertise you are buying and what you are paying in fees and costs.
Most people lack the knowledge to manage their own investment portfolio. A trusted financial advisor can help you figure out your goals, present different ways of forming portfolios, and ensure you understand the possible distribution of outcomes. This way, you can make informed choices about how to invest. Your advisor then keeps watch over what is happening, and together you revise your investment plan if needed.
Investing is a dynamic process and a lifelong journey. It’s having a philosophy you can stick with, considering the range of possibilities, and adjusting along the way. These are the keys to a better investment experience. Stay disciplined, control what you can control, and keep a long-term view on your destination so you can focus on what really matters and enjoy your life.
Distribution of Luck vs. Skill in US Equity Mutual Fund Performance: 1. The data shown here is derived from the CRSP Survivorship-Bias-Free Mutual Fund Database and Ken French’s data library. Methodology based on Fama and French (2010). Fama, Eugene F., and Kenneth R. French. 2010. “Luck versus Skill in the Cross-Section of Mutual Fund Returns.” The Journal of Finance 65(5) (2010): 1915–1947. Meyer-Brauns, Philipp. 2016. “Mutual Fund Performance through a Five-Factor Lens.” Dimensional Fund Advisors. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. The analysis follows the methodology of Fama and French (2010) and French (2008) using the Center for Research in Security Prices (CRSP) mutual fund data from 1984 to 2015. Only funds that invest primarily in US equities were included and different classes of the same fund were combined, with asset weights, into a single fund. To better focus on the performance of active managers, index funds were excluded from the analysis. To lessen the effect of incubation bias, funds with less than $50MM in assets under management as measured in December 2015 US dollars were not included in the analysis. A return history of at least 12 months after exceeding the $50MM AUM minimum for the first time was required to facilitate estimating benchmark regressions. Only funds that appear on CRSP at least five years before the end of the sample period were included in order to avoid a large number of new funds with short return histories. Tests for non-zero true α in actual fund returns use bootstrap simulations on returns that have the properties of fund returns, except that true α was set to zero for every fund. To set α to zero, a fund’s five-factor α estimate was subtracted from its monthly returns. A simulation run is a random sample (with replacement) of 384 months, drawn from the 384 calendar months of January 1984 to December 2015. Benchmark regressions were then estimated, fund by fund, on the simulation draw of months of zero-alpha adjusted returns, and funds that are in the simulation run for less than 12 months were excluded. 10,000 simulation runs were performed to produce a chance distribution of t(α) estimates for a world in which true α is zero. The projections or other information generated by bootstrapped samples regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results will vary with each use and over time.
Industry Mutual Fund Performance: 2. The sample includes funds at the beginning of the 15-year period ending December 31, 2017. Each fund is evaluated relative to the Morningstar index assigned to the fund’s category at the start of the evaluation period. So, if, for example, a fund changes from Large Value to Large Growth during the evaluation period, then its return will still be compared to the Large Value category index. Surviving funds are those with return observations for every month of the sample period. Winner funds are those that survived and whose cumulative net return over the period exceeded that of their respective Morningstar category index. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. See Dimensional's “Mutual Fund Landscape 2018” for more detail, including Morningstar categories included in the fund samples. Past performance is no guarantee of future results.