Investing fundamentals #7 – Look beyond past performance

In the seventh of a series of blogs about the ten fundamentals of investing, I explain why investors need to look beyond past performance when selecting suitable investment funds.

When choosing investment funds, it can be very tempting to pick them based on how well they have done in the past.

Despite the well known warning about past performance being no guide to future returns, investors often see the ability for a fund to beat the average in the past as ‘evidence’ it will do well in the future.

Funds that have performed well in the past are certainly not guaranteed to perform well in the future. In fact, history tells us that the top performing fund in one year is likely to underperform in subsequent years.

Assuming investors cannot therefore rely on past performance when picking investment funds, what other factors should they consider?

Our approach to fund selection starts with looking at consistency of performance, risk-adjusted returns and cost.

The ability for a fund manager to deliver consistent returns is a much better indicator of their long term potential than a strong period of short-term performance, in our opinion.

Risk-adjusted returns consider how much risk the fund manager took to achieve a certain level of performance, which is often quite revealing as some of the ‘top’ fund managers are exposing investor cash to very high levels of risk in order to get the returns they achieve.

Cost is important because the less you pay for fund management, the more of the investment returns you get to keep. All other things being equal, a fund with lower ongoing charges is going to deliver a better return for investors.

The most important factor in fund selection is making sure the fund matches your investment objectives and does a good job of populating your chosen asset allocation mix.

Read about all ten investing fundamentals by downloading our free guide:

The Investing Fundamentals Guide 2014