Is Buying A Hot Investment Fund A Big Mistake?

Today, we’re going over how hot mutual funds that you see all of the time in top ten lists in Money Magazine, Fortune, or CNBC will lose you money.

The two charts here show all of the mutual funds in the US in two separate periods, from 2002 to 2006, and 2007 to 2011.  Each time period is broken down into four sections, or quartiles, by fund performance.

There were 377 funds in the top 25%, or the top quartile in the first period.  Of those 377 funds only 32, or 8%, stayed in the top 25% of all investment funds in the next five year period.

36 funds, around 10% dropped into the second quartile in the 2007 to 2011 period, and it just gets worse.  21% of funds dropped to the third quartile, and this is pretty incredible, 46% of the hottest mutual funds in the period from 2002 to 2006, dropped to the bottom quartile in the 2007-2011 period.  That means that 175 of the best mutual funds in the past period, dropped to the very bottom of all mutual fund performance in the next period.  And I don’t know about you, but that makes me want to avoid the “Hot Funds” that the talking heads want you to buy.

Even more incredible than many top performers dropping into last in the second period, is the fact that 55 funds ceased to exist.  Investment companies closed 15% of all the top funds because their performance was so bad they couldn’t support their expenses, or their investors did not get what they were promised so they all left the fund.

This graphic just shows that actively managed funds that achieve top performance in one period typically do not repeat their success in the next period.

So before you go out and invest in the next hot mutual fund, remember this graph.  By investing in one of the hottest funds that they say you must have “right now”, you have a 75% chance of doing worse than average over the next 5 year period and a 92% chance to drop out of the top performers.  This is just one of the many reasons why picking a good fund manager is so tough, they are just so inconsistent.

Buying active mutual funds based on what the financial entertainment industry tells you is one of the most grievous retirement planning mistakes out there.  Instead of buying hot mutual funds, develop a sound strategy that uses financial data to support your choices.   I cover more retirement investing mistakes in my video course Off Wall Street Wealth: How The Wealthy Invest For Retirement as well as a 4-step system to get you on track for retirement.  Sign up for the free course in the form below.

So, have you ever lost money by buying a hot investment fund?

Do you have a different opinion on this?

Let me know in the comments below.