When it comes to equity investing, the difference between luck and skill is primarily a matter of consistency. If you choose to invest in a fund or ETF designed to passively track some stock market index you are practically guaranteed to get market returns. Of course you need to make sure to utilize funds that are operationally efficient (e.g. minimize tracking errors and/or avoid front-running). On the other hand, if you pick individual stocks or select actively-managed funds – in effect hiring a manager to pick individual stocks – you are betting that you can beat the market. Anyone can be lucky enough pick a fund or stock that happens to outperform in any given year. The only way to know if skill is involved is to be able to do it routinely.

S&P Dow Jones Indices produces an annual persistence scorecard which measures the consistency of U.S. mutual fund performance. The data from June 2022 with respect to actively-managed equity funds is striking. Among those that were in the top performance quartile (25%) of all equity funds from July 2019 through June 2020, not one remained in the top quartile two years later. If you relax the threshold to include all funds in the top half, only 4% were able to perform above average consistently during the same period.

What about for longer periods? The results are equally telling. Of all the equity funds in the top quartile for 2017-2018, none remained as top-quartile funds after five years. And only 1% remained in the top half over that period. Compare that to the probability that a randomly chosen fund outperforms the average over each of the following four years. It’s 50% x 50% x 50% x 50% or 6.25%. In other words, an investor in 2018 would have done better choosing an equity fund by flipping a coin rather than by basing the decision on the previous year’s performance.

As a side note the report found that the returns of actively-managed fixed income funds were somewhat more persistent over time than with equity funds. And the analysis did not include ETFs, possibly because the vast majority is not actively-managed. (The latter is changing however; hopefully future reports will start to incorporate them as well.)

What about fear of missing out if a particular stock happens to take off? Well, if you invest in a mutual fund or ETF based on the Russell 3000 or other total stock market index, then you are buying every stock in that index. You will be participating in every stock craze, be it Tesla or even Game Stop. But if you concentrate your investment portfolio in a smaller set of stocks – thinking that you’ll hit the jackpot because they’ve done so well in the past – you are really relying on luck. That is, you are gambling with your savings. That’s a pretty risky way of trying to ensure that you have enough money to fund your retirement lifestyle.

You can find the report here: https://www.spglobal.com/spdji/en/documents/spiva/persistence-scorecard-mid-year-2022.pdf.