Mutual Funds: Understanding Past Performance & Future Potential

When it comes to mutual funds, there are a lot of common misconceptions that run rampant in the industry. One of the most common misconceptions is that last year's performance is a strong indicator of what will happen this year.

Past Performance

When you are getting involved in the mutual fund market, you need to make sure that you understand one of its most basic rules. That rule is that past performance does not tell you anything about what is going to happen in the future. While seeing a solid performance last year can make you feel good about your investment, it does not prove anything.

Cyclical

Mutual funds are typically tied to stocks or some other underlying asset. Most stocks and other securities are cyclical in nature. This means that they will move up and down with the market overall. Therefore, after a certain period of exceptional returns, the market will tend to go through a downtrend. If you see that a mutual fund has had a good year, it may be because the stocks that make up the fund were at the top of their cycle. The next year, they might go through a big downtrend and actually lose money.