If a mutual fund did really well last year, then statistically speaking, is it likely going to do bad this year?
"This can be answered by looking at the fine print for any prospectus for any stock, bond or mutual fund. It says: ""Past performance is not an indicator of future performance."". A mutual fund is a portfolio of common stocks, managed by somebody for a fee. There are many factors that can drive performance of a fund up or down. Here are a few:  I'm sure there are many more market influences that I cannot think of that push fund prices up or down. What the fund did last year is not one of them. If it were, making money in the mutual fund market would be as easy as investing in last year's winners and everyone would be doing it." Nearly all long-lived active funds underperform the market over the long run. The best they can hope for in almost all cases is to approximate the market return. Considering that the market return is ~9%, this fund should be expected to do less well. In terms of predicting future performance, if its average return is greater than the average market return, its future average return can be expected to fall. From a mathematical point of view the stats do not change depending on past performance. Just because a fund is lucky one year doesn't mean that it will be unlucky the next. Consider tossing a coin, the chance of heads is 50%. If you have just thrown 3 heads, the chance of heads is still 50%. It doesn't go down.  If you throw 10 heads in a row the chance of a heads is still 50%, in fact you many suspect there is something odd about the coin, if it was an unfair coin then the chance of a heads would be higher than 50%. It could be the fund is better run, but there could be other reasons, including random chance. Some funds will randomly do better and some will randomly do worse What you do know is that if they did better than average other funds have done worse, at least for last year.
"In the case of a specific fund, I'd be tempted to get get an annual report that would disclose distribution data going back up to 5 years.  The ""View prospectus and reports"" would be the link on the site to note and use that to get to the PDF of the report to get the data that was filed with the SEC as that is likely what matters more here.  Don't forget that mutual fund distributions can be a mix of dividends, bond interest, short-term and long-term capital gains and thus aren't quite as simple as stock dividends to consider here." So you're saying as long as they are always slightly up investors will be happy? I can believe that. Also, here is some evidence to support you. http://www.hedgeweek.com/2017/07/20/254194/hfr-reports-hedge-funds-allocations-beat-redemptions  Though you have to admit negative returns must be especially hard to own to your investors when everything is up "My two cents: I am a pension actuary and see the performance of funds on a daily basis. Is it normal to see down years? Yes, absolutely. It's a function of the directional bias of how the portfolio is invested. In the case of a 401(k) that almost always mean a positive directional bias (being long). Now, in your case I see two issues: The amount of drawdown over one year. It is atypical to have a 14% loss in a little over a year. Given the market conditions, this means that you nearly experienced the entire drawdown of the SP500 (which your portfolio is highly correlated to) and you have no protection from the downside. The use of so-called ""target-date funds"". Their very implication makes no sense. Essentially, they try to generate a particular return over the elapsed time until retirement. The issue is that the market is by all statistical accounts random with positive drift (it can be expected to move up in the long term). This positive drift is due to the fact that people should be paid to take on risk. So if you need the money 20 years from now, what's the big deal? Well, the issue is that no one, and I repeat, no one, knows when the market will experience long down moves. So you happily experience positive drift for 20 years and your money grows to a decent size. Then, right before you retire, the market shaves 20%+ of your investments. Will you recoup these damages? Most likely yes. But will that be in the timeframe you need? The market doesn't care if you need money or not. So, here is my advice if you are comfortable taking control of your money. See if you can roll your money into an IRA (some 401(k) plans will permit this) or, if you contribute less that the 401(k) contribution limit you make want to just contribute to an IRA (be mindful of the annual limits). In this case, you can set up a self-directed account. Here you will have the flexibility to diversify and take action as necessary. And by diversify, I don't mean that ""buy lots of different stuff"" garbage, I mean focus on uncorrelated assets. You can get by on a handful of ETFs (SPY, TLT, QQQ, ect.). These all have liquid options available. Once you build a base, you can lower basis by writing covered calls against these positions. This is allowed in almost all IRA accounts. In my opinion, and I see this far too often, your potential and drive to take control of your assets is far superior than the so called ""professionals or advisors"". They will 99% of the time stick you in a target date fund and hope that they make their basis points on your money and retire before you do. Not saying everyone is unethical, but its hard to care about your money more than you will." It means someone's getting paid too much. I'd check the sharpe ratio and compare that to similar funds along with their expense ratio. So in some scenarios it's not necessarily a bad thing but being informed is the important thing Could somebody explain to me exactly why the writer doesn't think this is a win for passive investing? Aren't 'this could happen' statements only relevant to active managers so if you already believe that active investing is more successful than passive then of course you'll just fit this situation to 'there is still potential for major loss, the S&amp;P has tanked x many times' because you believe that there are predictable patterns in markets while the passive investor says that isn't true. "Forecasts of stock market direction are not reliable, so you shouldn't be putting much weight on them.  Long term, you can expect to do better in stocks, but obtaining this better expected return has the danger of ""buying in"" to the market at a particularly bad moment, leading to a substantially lower return.  So mitigate that risk while moving in a big piece of cash by ""dollar cost averaging"".  An example would be to divide your cash hoard (conceptually) into say six pieces, and invest each piece in the index fund two months apart.  After a year you will have invested the whole sum at about the average of the index for the year." Terminology aside.  Your gains for this year in a mutual fund do seem low.  These are things that can be quickly, and precisely answered through a conversation with your broker. You can request info on the performance of the fund you are invested in from the broker.  They are required to disclose this information to you.   They can give you the performance of the fund overall, as well as break down for you the specific stocks and bonds that make up the fund, and how they are performing. Talk about what kind of fund it is.  If your projected retirement date is far in the future your fund should probably be on the aggressive side.  Ask what the historic average is for the fund you're in.  Ask about more aggressive funds, or less if you prefer a lower average but more stable performance.  Your broker should be able to adequately, and in most cases accurately, set your expectation. Also ask about fees.  Good brokerages charge reasonable fees, that are typically based on the gains the fund makes, not your total investment.  Make sure you understand what you are paying. Even without knowing the management fees, your growth this year should be of concern.  It is exceptionally low, in a year that showed good gains in many market sectors.  Speak with your broker and decide if you will stick with this fund or have your IRA invest in a different fund. Finally JW8 makes a great point, in that your fund may perform well or poorly over any given short term, but long term your average should fall within the expected range for the type of fund you're invested in (though, not guaranteed). MOST importantly, actually talk to your broker.  Get real answers, since they are as easy to come by as posting on stack. That is such a vague statement, I highly recommend disregarding it entirely, as it is impossible to know what they meant. Their goal is to convince you that index funds are the way to go, but depending on what they consider an 'active trader', they may be supporting their claim with irrelevant data Their definition of 'active trader' could mean any one or more of the following: 1) retail investor 2) day trader 3) mutual fund 4) professional investor 5) fund continuously changing its position 6) hedge fund. I will go through all of these. 1) Most retail traders lose money. There are many reasons for this. Some rely on technical strategies that are largely unproven. Some buy rumors on penny stocks in hopes of making a quick buck. Some follow scammers on twitter who sell newsletters full of bogus stock tips. Some cant get around the psychology of trading, and thus close out losing positions late and winning positions early (or never at all) [I myself use to do this!!]. I am certain 99% of retail traders cant beat the market, because most of them, to be frank, put less effort into deciding what to trade than in deciding what to have for lunch. Even though your pension funds presentation is correct with respect to retail traders, it is largely irrelevant as professionals managing your money should not fall into any of these traps. 2) I call day traders active traders, but its likely not what your pension fund was referring to. Day trading is an entirely different animal to long or medium term investing, and thus I also think the typical performance is irrelevant, as they are not going to manage your money like a day trader anyway. 3,4,5) So the important question becomes, do active funds lose 99% of the time compared to index funds. NO! No no no. According to the WSJ, actively managed funds outperformed passive funds in 2007, 2009, 2013, 2015. 2010 was basically a tie. So 5 out of 9 years. I dont have a calculator on me but I believe that is less than 99%!   Whats interesting is that this false belief that index funds are always better has become so pervasive that you can see active funds have huge outflows and passive have huge inflows. It is becoming a crowded trade. I will spare you the proverb about large crowds and small doors. Also, index funds are so heavily weighted towards a handful of stocks, that you end up becoming a stockpicker anyway. The S&P is almost indistinguishable from AAPL. Earlier this year, only 6 stocks were responsible for over 100% of gains in the NASDAQ index. Dont think FB has a good long term business model, or that Gilead and AMZN are a cheap buy? Well too bad if you bought QQQ, because those 3 stocks are your workhorses now. See here 6) That graphic is for mutual funds but your pension fund may have also been including hedge funds in their 99% figure. While many dont beat their own benchmark, its less than 99%. And there are reasons for it. Many have investors that are impatient. Fortress just had to close one of its funds, whose bets may actually pay off years from now, but too many people wanted their money out. Some hedge funds also have rules, eg long only, which can really limit your performance. While important to be aware of this, that placing your money with a hedge fund may not beat a benchmark, that does not automatically mean you should go with an index fund. So when are index funds useful? When you dont want to do any thinking. When you dont want to follow market news, at all. Then they are appropriate. Stock index funds are likely, but not certainly, to be a good long-term investment.  In countries other than the USA, there have been 30+ year periods where stocks either underperformed compared to bonds, or even lost value in absolute terms.  This suggests that it may be an overgeneralization to assume that they always do well in the long term.  Furthermore, it may suggest that they are persistently overvalued for the risk, and perhaps due for a long-term correction.  (If everybody assumes they're safe, the equity risk premium is likely to be eaten up.) Putting all of your money into them would, for most people, be taking an unnecessary risk.  You should cover some other asset classes too.  If stocks do very well, a portfolio with some allocation to more stable assets will still do fairly well.  If they crash, a portfolio with less risky assets will have a better chance of being at least adequate. "Can you easily stomach the risk of higher volatility that could come with smaller stocks? How certain are you that the funds wouldn't have any asset bloat that could cause them to become large-cap funds for holding to their winners? If having your 401(k) balance get chopped in half over a year doesn't give you any pause or hesitation, then you have greater risk tolerance than a lot of people but this is one of those things where living through it could be interesting. While I wouldn't be against the advice, I would consider caution on whether or not the next 40 years will be exactly like the averages of the past or not. In response to the comments: You didn't state the funds so I how I do know you meant index funds specifically? Look at ""Fidelity Low-Priced Stock"" for a fund that has bloated up in a sense. Could this happen with small-cap funds? Possibly but this is something to note. If you are just starting to invest now, it is easy to say, ""I'll stay the course,"" and then when things get choppy you may not be as strong as you thought. This is just a warning as I'm not sure you get my meaning here. Imagine that some women may think when having a child, ""I don't need any drugs,"" and then the pain comes and an epidural is demanded because of the different between the hypothetical and the real version. While you may think, ""I'll just turn the cheek if you punch me,"" if I actually just did it out of the blue, how sure are you of not swearing at me for doing it? Really stop and think about this for a moment rather than give an answer that may or may not what you'd really do when the fecal matter hits the oscillator. Couldn't you just look at what stocks did the best in the last 10 years and just buy those companies? Think carefully about what strategy are you using and why or else you could get tossed around as more than a few things were supposed to be the ""sure thing"" that turned out to be incorrect like the Dream Team of Long-term Capital Management, the banks that were too big to fail, the Japanese taking over in the late 1980s, etc. There are more than a few times where things started looking one way and ended up quite differently though I wonder if you are aware of this performance chasing that some will do." Is it POSSIBLE? Of course. I don't even need to do any research to prove that. Just some mathematical reasoning: Take the S&P 500. Find the performance of each stock in that list over whatever time period you want to use for your experiment. Now select some number of the best-performing stocks from the list -- any number less than 500. By definition, the X best must be better than or equal to the average. Assuming all the stocks on the S&P did not have EXACTLY the same performance, these 10 must be better than average. You now have a diversified portfolio that performed better than the S&P 500 index fund. Of course as they always say in a prospectus, past performance is not a guarantee of future performance.  It's certainly possible to do. The question is, if YOU selected the stocks making up a diversified portfolio, would your selections do better than an index fund? "You absolutely should consider expenses. Why do they matter when the ""sticker price"" already includes them?  Because you can be much more certain about what the expense ratio will be in the future than you can about what the fund performance will be in the future. The ""sticker price"" mixes generalized economic growth (i.e., gains you could have gotten from other funds) with gains specific to the fund, but the expense ratio is completely fund-specific.  In other words, when looking at the ""sticker price"" performance of a fund, it's difficult to determine how that performance will extend into the future.  But the expense ratio will definitely carry into the future.  It is rare for funds to drastically change their expense ratios, but common for funds to change their performance. Suppose you find a fund that has returned a net of 8% over some time period and has a 1% expense ratio, and another fund that has returned a net of 10% but has a 2% expense ratio.  So the first fund returned 9%-1% = 8% and the second returned 12%-2%=10%.  There are decent odds that, over some future time period, the first fund will return 10%-1%=9% while the second fund will return 10%-2%=8%.  In order for the second fund to be better than the first, it has to reliably outperform it by 1%; this is harder than it may sound.  Simply put, there is a lot of ""noise"" in the fund performance, but the expense ratio is ""all signal"". Of course, if you find a fund that will reliably return 20% after expenses of 3%, it would probably make sense to choose that over one that returns 10% after expenses of 1%.  But ""will reliably return"" is not the same as ""has returned over the past N years"", and the difference between the two phrases becomes greater and greater the smaller N is.  When you find a fund that seems to have performed staggeringly well over some time period, you should be cautious; there is a good chance that the future holds some regression to the mean, and the fund will not continue to be so stellar. You may want to take a look at this question which asked about Morningstar fund ratings, which are essentially a measure of past performance.  My answer references a study done by Morningstar comparing its own star ratings vs. fund expenses as a predictor of overall results.  I'll repeat here the take-home message: How often did it pay to heed expense ratios? Every time. How often did it pay to heed the star rating? Most of the time, with a few exceptions. How often did the star rating beat expenses as a predictor? Slightly less than half the time, taking into account funds that expired during the time period. In other words, Morningstar's own study showed that its own star ratings (that is, past fund performance) are not as good at predicting success as simply looking at the expense ratios of the funds." Since the vast majority of fund managers/big investors run private entities, it's not possible to track their performance. It's possible to look at what they are holding (that's never real-time information) and emulate their performance. This is Ellie Lan, investment analyst at Betterment. To answer your question, American investors are drawn to use the S&P 500 (SPY) as a benchmark to measure the performance of Betterment portfolios, particularly because it’s familiar and it’s the index always reported in the news. However, going all in to invest in SPY is not a good investment strategy—and even using it to compare your own diversified investments is misleading. We outline some of the pitfalls of this approach in this article: Why the S&P 500 Is a Bad Benchmark. An “algo-advisor” service like Betterment is a preferable approach and provides a number of advantages over simply investing in ETFs (SPY or others like VOO or IVV) that track the S&P 500.  So, why invest with Betterment rather than in the S&P 500? Let’s first look at the issue of diversification. SPY only exposes investors to stocks in the U.S. large cap market. This may feel acceptable because of home bias, which is the tendency to invest disproportionately in domestic equities relative to foreign equities, regardless of their home country.  However, investing in one geography and one asset class is riskier than global diversification because inflation risk, exchange-rate risk, and interest-rate risk will likely affect all U.S. stocks to a similar degree in the event of a U.S. downturn. In contrast, a well-diversified portfolio invests in a balance between bonds and stocks, and the ratio of bonds to stocks is dependent upon the investment horizon as well as the individual's goals.  By constructing a portfolio from stock and bond ETFs across the world, Betterment reduces your portfolio’s sensitivity to swings. And the diversification goes beyond mere asset class and geography. For example, Betterment’s basket of bond ETFs have varying durations (e.g., short-term Treasuries have an effective duration of less than six months vs. U.S. corporate bonds, which have an effective duration of just more than 8 years) and credit quality. The level of diversification further helps you manage risk.  Dan Egan, Betterment’s Director of Behavioral Finance and Investing, examined the increase in returns by moving from a U.S.-only portfolio to a globally diversified portfolio. On a risk-adjusted basis, the Betterment portfolio has historically outperformed a simple DIY investor portfolio by as much as 1.8% per year, attributed solely to diversification.   Now, let’s assume that the investor at hand (Investor A) is a sophisticated investor who understands the importance of diversification. Additionally, let’s assume that he understands the optimal allocation for his age, risk appetite, and investment horizon. Investor A will still benefit from investing with Betterment.  Automating his portfolio management with Betterment helps to insulate Investor A from the ’behavior gap,’ or the tendency for investors to sacrifice returns due to bad timing. Studies show that individual investors lose, on average, anywhere between 1.2% to 4.3% due to the behavior gap, and this gap can be as high as 6.5% for the most active investors. Compared to the average investor, Betterment customers have a behavior gap that is 1.25% lower. How? Betterment has implemented smart design to discourage market timing and short-sighted decision making.  For example, Betterment’s Tax Impact Preview feature allows users to view the tax hit of a withdrawal or allocation change before a decision is made. Currently, Betterment is the only automated investment service to offer this capability. This function allows you to see a detailed estimate of the expected gains or losses broken down by short- and long-term, making it possible for investors to make better decisions about whether short-term gains should be deferred to the long-term. Now, for the sake of comparison, let’s assume that we have an even more sophisticated investor (Investor B), who understands the pitfalls of the behavior gap and is somehow able to avoid it. Betterment is still a better tool for Investor B because it offers a suite of tax-efficient features, including tax loss harvesting, smarter cost-basis accounting, municipal bonds, smart dividend reinvesting, and more. Each of these strategies can be automatically deployed inside the portfolio—Investor B need not do a thing. Each of these strategies can boost returns by lowering tax exposure. To return to your initial question—why not simply invest in the S&P 500? Investing is a long-term proposition, particularly when saving for retirement or other goals with a time horizon of several decades. To be a successful long-term investor means employing the core principles of diversification, tax management, and behavior management. While the S&P might look like a ‘hot’ investment one year, there are always reversals of fortune. The goal with long-term passive investing—the kind of investing that Betterment offers—is to help you reach your investing goals as efficiently as possible.   Lastly, Betterment offers best-in-industry advice about where to save and how much to save for no fee. The only way for a mutual fund to default is if it inflated the NAV. I.e.: it reports that its investments worth more than they really are. Then, in case of a run on the fund, it may end up defaulting since it won't have the money to redeem shares at the NAV it published. When does it happen? When the fund is mismanaged or is a scam. This happened, for example, to the fund Madoff was managing. This is generally a sign of a Ponzi scheme or embezzlement. How can you ensure the funds you invest in are not affected by this? You'll have to read the fund reports, check the independent auditors' reports and check for clues. Generally, this is the job of the SEC - that's what they do as regulators. But for smaller funds, and private (i.e.: not public) investment companies, SEC may not be posing too much regulations.