Don’t Be Fooled by Past Performance

It’s that time of year again. Mutual fund companies love quarter-ends and year-ends. They get to refresh and tout their performance numbers, but unless you look closely you can easily be mislead. For example, a fund advertising a three-year compound annual growth rate (CAGR) of 9.04% would likely attract a lot of attention; and most potential investors would assume the fund delivered returns of approximately 9.0% for each of the preceding three years. In reality, a fund can have widely disparate returns over the specified three-year period and still deliver a 9.04% CAGR. In some cases, one good year may be the driver of the performance. And there's nothing wrong with that unless the factors that prompted the performance are no longer present -- e.g., perhaps the fund has a different portfolio manager. Significant outperformance in a single year may also be due to an outsized bet on a particular security or sector -- or the manager may have just gotten lucky.

Consider the following example as a warning of why you need to examine year-by-year returns to truly understand how well the fund has performed and help identify what drove the performance. Do not allow yourself to be fooled by foolish numbers.

ABC FUND
Year 1: +35%
Year 2: -1%
Year 3: -3%
3-Year CAGR: 9.04%

XYZ FUND
Year 1: -3%
Year 2: -1%
Year 3: +35%
3-Year CAGR: 9.04%

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