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What Can We Learn from Past Performance?

Housekeeping note: Last Wednesday, I upgraded the hosting service for this site. Unfortunately, I messed up the email server in the process and didn’t notice it until Friday. So if you sent me an email last week and did not get a reply, please accept my apologies and resend the email, as I probably never received it.

When it comes to mutual funds, as we all know, past performance is not indicative of future results.

But past performance can still be useful information. One of my favorite ways to use such data is to get a quick, first-glance look at how similar two funds are.

For example, a reader recently asked about whether Fidelity Total Bond Fund (FTBFX) would be a suitable replacement for Vanguard Total Bond Market Index Fund (VBMFX) — he had wanted to use the Vanguard fund, but the Fidelity fund appeared to be the best bond fund available in his 401(k).

The following chart (produced via Fidelity’s website — see the end of this article for instructions on making similar charts) shows us how an investment of $10,000 in each of the funds would have done over the last 10 years.

Conclusion: They’re certainly not the same thing, but they don’t appear to be wildly different either. It’s at least close enough to merit further research (like comparing the funds’ holdings by looking up each fund on Morningstar and viewing the “portfolio” tab).

Or what if your 401(k) had access to Vanguard’s Large-Cap Index Fund (VLACX), rather than a total stock market fund? The following chart compares the fund’s performance since inception to the performance of Vanguard Total Stock Market Index Fund (VTSMX) over the same period.

Conclusion: “High correlation” would be an understatement. In terms of performance, these two funds are virtually identical — which makes sense, given the degree of overlap between the funds’ holdings.

Or what if you’re feeling tempted to switch from a short-term treasury fund to a long-term treasury fund in order to grab a couple extra percentage points of yield, but you want to get a quick feel for how much additional risk you’d be taking on? The following chart compares the 10-year performance of Vanguard’s Short-Term Treasury Fund (VFISX) to that of Vanguard’s Long-Term Treasury Fund (VUSTX).

Conclusion: These two funds are very meaningfully different. By reaching for that additional yield, you take on a pile of additional risk. (Remember how we discussed that the volatility of a bond fund is proportional to its average duration? This picture shows the difference between a 2-year average duration and a 15-year average duration.)

Important Caveats

Of course, the above past-performance-based comparisons come with some important caveats.

First and most importantly, this is just a first-glance sort of analysis. Before investing in a fund, you’d want to actually take a look at its expenses and its portfolio makeup.

Second, the more actively-managed a fund is, the less reliable this sort of comparison will be. For example, an actively managed stock fund could have performed very similarly to the S&P 500 in the past, but there’s no guarantee that would be the case going forward.

Finally, for index funds, such comparisons become much less meaningful if the fund has switched the index it tracks over the course of the period in question — like Vanguard Total International Stock Index Fund, for example. And the same goes for “funds of funds” that have changed their composition (like the Vanguard LifeStrategy funds and Target Retirement funds).

To make such charts on your own: Visit Fidelity’s website, then click “research,” then “mutual funds.” Then enter the ticker symbol for one of the funds in question. Then, under the resulting chart, enter the ticker symbol for the second fund in the field for “compare funds.”

Credit where credit is due: Boglehead forum member nisiprius has been using such visual comparisons in his posts for years. I’ve often found them to be quite enlightening, so I thought I’d share the idea with you.

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Comments

  1. Mike,

    This sounds like a great way to compare funds quickly- if the price history is visibly different then you don’t have to do any further research to know that the funds aren’t that similar.

    -Rick Francis

  2. thanks Mike for the tip about the use of past performance. I often like your articles but don’t have any comments per say. Perhaps you can add a “Like” button somewhere. Just a thought. Cheers!

If you want to discuss this article, I recommend starting a conversation over at the Bogleheads investing forum.
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