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Mutual Funds Fun Facts: One Stat Can Really Lead You to the Winners

By Motley Fool Staff – Oct 25, 2016 at 8:01PM

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If you expect that answer to be past performance, you’re not alone. (You’re not right, but you’re not alone.)

In this week's Motley Fool Answers, Alison Southwick and Robert Brokamp reveal some lesser-known facts about these pooled investment vehicles. First up, this remarkable tidbit: The best predictor of higher returns isn't history -- it's the costs.
A full transcript follows the video.

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This podcast was recorded on Oct. 4, 2016.

Alison Southwick: So without further ado, the first thing you maybe didn't, but probably should, know about mutual funds is that the costs are the most reliable indicator of future returns.

Robert Brokamp: Right. And when you're in a situation where you're picking a fund -- and a lot of people are, whether it's because they're looking for funds, or it's what you have as a choice in your 401(k) -- you have to decide which fund you should choose. And most people look at the past returns, but actually most studies indicate that returns may not be the best indicator of what will happen in the future.

S&P does something called its Persistence Scorecard. They basically take a look at which funds outperformed over one period and then how many of them continued to outperform over the subsequent period. For example, from March 2006 to 2011, of the top 25% of funds, the ones that were in the top quartile, what percentage do you think then remained at the top quartile from 2011 to 2016?

Southwick: Uh, five.

Brokamp: Well, no, it's a little better than that -- 17%.

Southwick: OK, sorry. I went too low.

Brokamp: You went too low, but that's still pretty remarkable.

Southwick: Yeah.

Brokamp: Thinking you've got a fund that performed in the top 25% over the past five years, so surely this is going to be a winner. You had a less than 1-in-5 chance of that continuing.

However, when you look at costs -- any study that breaks up the mutual fund universe based on costs -- over and over again it shows that lower-cost funds tend to outperform higher-cost funds. These, of course, are the averages. There are many great funds that have performed over the long term and charge at least medium, if not even above-average, costs. But on average, if you're looking to put the odds in your favor, go with a lower-cost fund.

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