For humor, let’s assume for a moment that historical ETF and mutual fund performance charts actually do have some useful information for individual investors. This might not actually be very funny to many fund investors who have been lured into lousy and expensive investments because of historical performance charts.
It can be hard to see humor, when the securities industry siphons away your assets through high management fees using the siren song of superior historical performance charts. The cover-your-rear small legal print in the footnote of the performance chart is actually right. Essentially, it says, “Don’t count on it.” And, you should not.
Interpreting rates of change from a cumulative performance chart is a challenge for many people. Visually, cumulative historical ETF and mutual fund performance charts are just very difficult to interpret. Most people would only look at the most recent values to see whether the fund’s cumulative performance to date is above or below the index.
Well, of course, if you are being sold to or advertised to, then the most recent cumulative performance will always be above the market index benchmark, because of selectivity. Selectivity means that fund companies select only their “winners” to promote. This is the easiest kind of fund to sell to naive individual investors — you know, “good” funds with “better” performance.
However, an ETF or mutual fund’s performance history that would truly exhibit investment management skill (or just a sting of good luck) is the relative rate of change in fund versus index benchmark asset valuation. The rate of change between the investment fund’s historical performance and the market index benchmark is what counts.
A consistently superior ETF or mutual fund would have a cumulative performance line that increasingly and consistently diverges from the benchmark index. Visually, the wedge between the two lines should just keep widening. On the other hand, a widening wedge could also describe the situation of an overly easy market index benchmark comparison and mediocre ETF or mutual fund performance.
Rarely do you see historical ETF or mutual fund performance graphs with increasingly widening lines — particularly since luck is a major factor and high investment management fees and high trading costs tend to drag fund performance down relative to appropriate market index benchmarks. If, for example, the lines diverged quickly ten years ago and then they maintained a relatively constant gap thereafter, that could mean that a very small and immature fund got lucky and/or it had a riskier investment portfolio profile.
Then, money from performance chasing individual investors flowed in, and the fund got much larger. If the gap between the lines on the chart does not increasingly widen, then this means that subsequent performance has just been mediocre. If the lines tend to narrow that demonstrates subsequent inferior performance. Cumulative performance could still be above the index due to a selectivity bias and/or an easy index benchmark, but the fund might really have been exhibiting mediocre or inferior performance for years.