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I'm reading The Little Book of Common Sense Investing and in chapter 11 it has a prologue,

IN SELECTING MUTUAL FUNDS, too many fund investors seem to rely less on sustained performance over the very long term (with all of its own profound weaknesses) than on superior performance over the short term. In 2016, over 150 percent of net investor cash flow went to funds rated four or five stars by Morningstar, the statistical service most broadly used by investors in evaluating fund returns.

I'm wondering how could it be 150 percent here? Does it mean people use leverage while buying mutual funds?

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  • It would have been nice for an article that criticises people for not understanding past-performance statistics to do a bit more to avoid putting their readers in a position of not understanding the article's past-performance statistics.
    – Lawrence
    Nov 27, 2023 at 14:45

2 Answers 2

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It says 150% of net investor cash flow. So investors both put money into funds and sell funds to get cash back. The difference between these two quantities is the net investor cash flow. The amount that went into 4 or 5 star funds however is a proportion of the money investors put into funds. As such it can be bigger than the net flow. The 150% here means this amount is one-and-a-half times as big as the net flow.

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Lets say that during the Spring of a typical year the net cash flow is $1 Trillion. That number represents all the money that flowed into funds, minus the money that flowed out of mutual funds. Some funds have a net inflow of money, others have a net outflow of money.

This is one possible way the flow can be more than 100% for some funds groups:

In the United States many people contribute money to their IRA and Roth IRA before the tax deadline. Those people take that opportunity to check the Morningstar ratings. They decide which fund based the numbers of stars.

Not only do they put their new money into those 4 or 5 star funds, but they may move money from their other funds. That means that in reality the net flow for those high rated funds is +$1.5 Trillion, while those funds with 3 or fewer stars has a net flow of -$0.5 Trillion. That means that 150% of the net flow for the market went to the highest rated funds.

The problem is that they could be moving money into what was hot last year, instead of what makes sense for their long term investing plan.

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  • Are "not" and "new" in the last sentence of your first para, both supposed to be "net"?
    – Vicky
    Nov 28, 2023 at 12:48
  • @Vicky thanks. Fixed it. Nov 28, 2023 at 12:56

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