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It seems one method to invest, without using much brain power, is to say, at the beginning of each month, if we have $500 to invest, then just look at the list of the best performing mutual funds over the last 10 years.

So if we already own that mutual fund, we can just buy the next highest one. Some of them are showing 25.88% per year for the past 10 years. For example:

FSELX  25.88%
FSPTX  22.92%

So we can just repeat, every month or every quarter, and invest in the best performing fund over the last 10 years. Does this method work, as it seems so simple?

P.S. But at the same time, I think there also is an investment method which is to buy the highest yielding stock in Dow 30, because that means the stock is beaten down and over the long term, should bounce back. So this method is "buying the underdog" rather than "buying the heroes". If that method works, then isn't buying the heroes the exact opposite and therefore should fail?

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    Did you read the warning that comes with absolutely every piece of investment advice: "Past performance is not necessarily an indicator of future performance." Sep 23 at 14:35
  • What do you mean by "work"? You've invested your money, which now is working for you. Unless the fund is a real outlier (e.g. it bought a lot of Tesla or Apple before their prices shot up), it will probably go on being profitable. But it probably won't be among the most profitable funds in the future. That's why index funds.
    – jamesqf
    Sep 23 at 16:48
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No.

Stock picking is a discipline that is rarely driven by skill. Funds that are in the top quartile for one year often will find themselves in a different quartile over the next years (c.f. regression to mean). If you do this for a longer time only few survivors with a great track record will remain, but many of them will just fall back the next year.

In a liquid market it is hardly possible to outperform the market over longer stretches as basically all available information is already priced into the market (c.f. efficient market hypothesis). While this is not perfect, it is good enough for a cheap passive index tracker to outperform basically all active funds on an after-cost basis once the time frame is long enough (c.f. SPIVA scorecard).

And even worse, a funds performance tends to degrade with its size. There simply are not that many undervalued stocks that are liquid and easy to recognize. A small fund may be able to build a concentrated portfolio on a handful of undervalued stocks but as they are growing, they cannot simply add more money to the same investments as this would impact the price. So large funds basically all hold the same large cap stocks and get a similar performance (c.f. closet indexing).

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There's a reason sayings about past performance not being indicative of future performance are basically cliché in investing circles: in large samples of mutual funds luck dictates the top and bottom performers just as it does with flipping coins, and buying one or the other will generally result in the same thing you would get buying the best/worst coin flippers at any given point: average performance going forward. You will be also be able to find many of these types of rules that back test well - virtually none which perform well going forward.

Also worth noting basic trading strategies like this have all been long priced in to highly liquid markets - zillions of smart rich people moving trillions in capital around don't leave stuff like this lying around: as a general rule in any form of trading any idea you can read about or trades off very simple rules is either wrong or was priced in and removed as an edge long ago.

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Can it work: absolutely, yes. Will it work: who knows, it's a coin flip, same as any other investment strategy.

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  • I guess unless, some UK research has found that, doing so works against you Sep 23 at 8:45
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One reason why fund X has a great return over the last 10 years might be that 10 years ago it was at the depth of a massive drop, and the conditions that caused that drop were easing. Their numbers were along for the ride. It could be that if you looked at 9 or 11 years their numbers would be below average.

Now all you have to do is predict what conditions will occur over the next 9 to 11 years.

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The main problem with buying the best performers is that the effect of being the "best performer" is a high price. So you're "buying high" hoping that the performance of the past 10 years will continue. History has shown that a better strategy is to "buy low" with either knowledge or hope that the low point is temporary and the investment is due for a rebound. This is the cornerstone of "value investing" (meaning buying low, not necessarily based on past performance, but on fundamentals or comparisons to similar investments).

Of course, no one can predict the future in any case, but it's not hard to test your strategy. Look at the 10 best performing funds from 2000-2010 and see how they performed from 2010-2020. Then look at the best performers from 2001-2011 and see how they performed from 2011 to 2021. That will give you a rough idea if your strategy is viable.

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So this method is "buying the underdog" rather than "buying the heroes". If that method works, then isn't buying the heroes the exact opposite and therefore should fail?

Buying the heroes works over a shorter time frame (3-12 months) - this is called momentum investing. Buying the underdog works over a longer time frame (years) - this is called value investing or contrarian investing.

Two prominent funds that write in great detail about these matters are:

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