Should I buy a mutual fund that’s outperformed?

If you’ve heard this before, let’s make something clear. The principle isn’t that you should never own or hold a mutual fund that has outperformed its benchmark - but rather, it’s that past outperformance alone isn’t a reliable reason to do so. But a lot of people mistakenly think it is (sometimes, that even includes your investment advisor). 

What does the data say?

Mutual funds that outperform their passive equivalents, on an after fee basis, are rare. On average, less than one in ten Canadian domiciled managers outperformed their passive index over the past 10 years, as measured by the SPIVA Canada Scorecard, across a number of categories.

What’s more, even if you are invested in a fund that has outperformed, the odds of that outperformance continuing are low, historically. Skill may persist, but luck is random and fleeting. Studies of fund performance consistency show that across asset classes and styles, very few managers remain in the top ranks over time. In practice, periods of outperformance are more often explained by luck than by skill. If you flip a coin 10 times, you could get 10 heads in a row – but, you wouldn’t want to bet on it happening again and again.

A super important math problem (please don’t turn away)

There's simple but powerful arithmetic that explains why actively managed funds struggle. The market's return gets shared by everyone who invests in it. If passive investing captures the entire "market return", then all active investors combined must also earn the market return (before fees). At its core, active investing is a zero sum game - for every winner who outperforms, there is a laggard who underperforms.

And active management isn’t free. When you factor in higher management fees, trading costs, and tax implications from buying/selling assets more frequently, collectively, active managers are more or less destined to underperform the market by the amount of these added costs. 

This doesn't mean no active manager can ever outperform - some will. But identifying those managers ahead of time is extremely difficult (as we showed above). And for most investors, the math makes low-cost, passive investing the smarter bet from the start.

So, what can you do? Focus on what matters

Instead of making decisions solely based on how an investment has performed, it’s in your best interest to consider the following.

How the fund fits into your overall portfolio, and if it aligns with your risk tolerance, time horizon, or diversification needs. The fund should play a clear role, complement your broader investment strategy, and fit within your financial plan.

Fees are pretty important, too, because they can erode future returns. The impact of fees compounds over time. 

Time and consistency win, because the most successful investors aren’t the ones who pick the hottest funds, at the best time to buy - they’re the ones who stick to a plan through good times and bad.

Concluding thought

It’s important to not let past returns trick you into poor decisions. Instead of asking yourself “what fund performed the best last year”, ask yourself, “what investments make sense for my situation and will help me achieve my goals with the highest likelihood?”. Your future self will thank you for focusing on what matters most: long-term planning, taking the right amount of risk, and controlling what you can control (like costs).