HomeA way that investors get ripped off and in a sense rip themselves off is based on the culture of performance in the mutual fund industry. If you stop and think about it there is absolutely no reason that the past has to equal the future. If you have not been particularly successful as a stock investor in the past, for instance, there is no reason that you won't be unsuccessful in the future. One reason I hope that you are reading this article is that you want to improve as an investor.
Let's discuss how professional gamblers profit in Las Vegas. Card counters are a type of professional gambler that uses their memory of what card cards have been dealt out of a deck in a game of blackjack (also called 21). Since there are only a certain number of each type of card they can increase their bets when it is more likely that they will win then lose. This works because after the shuffle the deck starts with a certain composition and a number of games are played until the next shuffle. Toward the end of the deck you can know what may be coming out if you are paying attention because each hand in the deck is depends on what has been dealt before.
There are no professional gamblers who count the numbers rolled on a pair of dice on the craps tables. This is because there are only two dice and each roll is different. In other words, each roll of the dice is independent of any other roll. Since each roll is different it doesn't matter what was rolled in the past.
The same thing would happen if the deck in a game of blackjack were shuffled each time between hands. This is a lot like the stock market where we don't know what the general level will be from time to time because of random information entering the market in the sort term. Mutual fund managers try to outsmart the market in the short term instead of patiently waiting in the long term where it is more likely to correctly determine if stocks are high or low.
So why then does the public pay so much attention to the nonsensical advertising of mutual funds that brag about prior performance in past years? Mutual funds buy expensive ads in newspapers, magazines, and on television where they tout their performance over the past one, three, five, and ten years. The mutual fund industry irresponsibly promotes this 'culture of performance,' even though it knows perfectly well that it misleads investors.
Studies have shown that if you take the top 10% highest yielding funds in any year, four out of five of them will not be in the top 10% a year later! For this reason I strongly recommend that if you can only buy mutual funds, as in the case of the 401(k), then restrict your purchases to indexed funds like the Vanguard 500 (VFINX).
About the author: ABOUT THE AUTHOR: Dr. Scott Brown, Ph.D., the Wallet Doctor, is a successful investor. Dr. Brown holds a Ph.D. in finance. The Wallet Doctor is sought after for investment advice and coaching. For more information visit Dr. Brown's site at www.BonanzaBase.com or sign up for his investment tips at www.WalletDoctor.com