MANISHA THAKOR: Hands down, the biggest mistake I see investors making when analyzing fund returns is not putting them in broader historical context.

    For the period 1927 to 2013 the S&P 500 generated a nominal compound annual return of 10.1%, long-term government bonds  5.5%, and one month T-bills 3.5% according to Ibbotson and Barclays Capital data.  Thus, a portfolio which was allocated over that time period 50% to stocks and 50% to bonds (split evenly between long-term bonds and T-bills) would have generated a return of 7.3%.
    Over the short run, there can be a fair amount of deviation from these long-run figures. Stocks returns have the widest variability and T-bills have the lowest. Since 1927 the annual standard deviation of returns of the S&P 500 was 20.3%, long-term government bonds was 9.9%, and one-month T-bills was 3.1% (based on Ibbotson & Barclays Capital data).  In plain English that means there can be individual years that are higher or lower than the long run average but over the long-run, returns tend to regress to the mean.

    All this is to say when looking at a particular mutual fund that has generated performance meaningfully outside the long-run historical numbers the key question to ask is: What is it about this fund’s strategy that leads me to think it will continue to buck the historical pull back to the average?  With data flowing around the globe at an ever-increasing rate, the ability to (legally) have and act upon information others are not aware of is increasingly scarce.

    So before getting too enamored of the return of a single fund or strategy, the prudent investor will think about that individual fund’s return in the context of their long term return needs–and ask what are the odds of receiving a déjà vu return “all over again.”


    Read the latest Investing in Funds & ETFs Report.