Build a Better Investment Strategy: Why Chasing Past Returns Doesn’t Work and What To Do Instead

This episode of the Canadian Money Roadmap explores why chasing past investment returns is a losing strategy. 

Hosts Evan and Sam explain that actively managed funds overwhelmingly underperform their benchmarks over time. 

They advocate for an evidence-based approach built on broad diversification, low costs, and factor-based investing (size, value, and profitability) aligned with a personalized financial plan.

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Transcript

SPEAKER_01 0:00

If you want to make money in the investment markets, you have to remember one critical concept. You cannot buy yesterday's returns. You can only get the returns that are happening in the future. So, how do you set up your portfolio in such a way to do that? Is chasing returns the best way to do it? In this episode of the Canadian Money Roadmap, we are going to discuss why persistence in investment fund managing is so difficult and what you should be doing instead. Okay, Sam, we are just coming out of the end of the NBA playoffs here, and unfortunately, my San Antonio Spurs know I am not a bandwagon jumper. I have been on board the Spurs train since 1998. We had an absolute collapse when people were saying going into the finals that this was a foregone conclusion, that the finals was happening in the Western Conference against the Thunder. No, this was not the case. This team absolutely crumbled under pressure, even though they might have had some of the better top-end talent. You can make all sorts of arguments there. They had home court advantage. It didn't matter. They got smoked, and I'm really disappointed about it. Your thoughts.

SPEAKER_00 1:12

Well, I thought, you know, the New York Knicks certainly had a well-oiled machine, and the chemistry and the kind of cohesion of the team maybe brought them forward. But a bit of an example of where the past performance, the Spurs had won more games during the regular season and things like that, was not predictive of the future returns in the finals.

SPEAKER_01 1:33

Yeah, and in in the NBA here, there's been a different champion every year since the Raptors won it back in 2019. And so persistence in sports, even though, you know, going into the next season, it's like, why wouldn't you just pick last year's winner to repeat? Because it's really hard, right? Sports is one thing. You know, you see this across all sports in general. Jays made the World Series last year. Who knows? They're not looking particularly strong this year to be able to make it back. But this kind of concept is present in investing as well, where persistence and you know, the having past successes is really hard to repeat and to do it over and over again.

SPEAKER_00 2:19

Yeah, for sure. And there's lots of evidence to kind of back that up. What we want to talk about today is the pull of the past returns in getting investors to kind of invest in certain mutual funds or certain products. And it's, you know, it's very natural to want to use past returns to predict future outcomes, but there's a there's a there's no correlation between those two things. And it's often the case in sports, as you're saying as well. The teams that did well last year, things have changed, the conditions have changed in lots of cases in the league. And the same goes with investing as conditions change, as the economy changes and things like that. It's gets harder for teams that did well, or funds, I should say, that did well in the past to do this as well in the future.

SPEAKER_01 2:59

Yeah, and the same thing can be true with individual stocks, perhaps, or different sectors, different countries, all sorts of different things. And it's easy to get sucked into this. Like this isn't some foolish thing that people should, you know, it is not so obvious that people should be avoiding this because when something is successful, it's like, well, this is good. Why wouldn't I want to own this? And in some cases, you know, that's a fair thing to suggest. But the allure of chasing the returns, buying the the ETF, the fund, the stock, whatever, after a meteoric rise, or even just marginal outperformance over an extended period of time might not necessarily be the case. And so I've seen this recently here in our work, you know, I'm familiar with dozens, at least hundreds, probably, of individual funds and some managers across different fund companies, across the industry. And I've heard lots of stories over time of different investing approaches and different management styles. And there's so many, we've talked about this on the podcast before. And these are brilliant people with armies of analysts and people that are trying to make money over time. And the stories are always out there of all these different funds that are performing really well, and then maybe not afterwards, right? And so I've seen this in statements that we've received from prospective clients where their portfolio starts to look like a collection of funds that have performed well recently, but yet their actual realized returns in the account don't really line up. And so you see this from DIYers, perhaps, of chasing whatever is hot and interesting. But it's also here in the professional investing world, too, where advisors will often fill up clients' accounts or switch things over when things don't go well. It's like, oh, let's switch over to this one. This one's had a really good tenure track record. And then that was just last year's performance or last decade's performance. That doesn't necessarily mean that that's going to translate into performance in the future. And so there's this constant churning that often happens. I'm not saying this is the case with everybody, but it's really common. And you can see it. You can see the fun flows into these funds as soon as there's outperformance. There's more money that flows in after the performance happens. And then when it declines and it decreases in value, flows come out of these funds. It's happening. And people aren't necessarily buying these on their own. Again, they're getting professional advice on this, but sometimes that professional advice isn't quite good enough.

SPEAKER_00 5:33

Yeah, and this brings us into it. I mean, it's a good point to look at some of the research around fund performance and the persistence of fund performance. And so one good resource for this comes from Spiva, so the SP indices versus active research they do, and they do persistence scorecards, which basically means they look at a bunch of funds in this, in this case, Canadian context, how these actively managed funds did over a previous period and how they did after that period to just kind of see how consistent some of these returns can be. They do this every year, but the most recent in 2025 found that Canadian active funds, looking at equity funds specifically, 93.4% of Canadian active funds underperformed the index. And lots of those performed very well in previous years. So there's this lack of persistence we're seeing. There's not a correlation between these past returns and the future returns in these active managed funds.

SPEAKER_01 6:25

Yeah, can you get into like the number of like funds that were in the top half of all options and how often they outperformed in the next period of time?

SPEAKER_00 6:35

Yeah, for sure. For example, one is that they'd looked at seven different categories from Canadian equity to US equity to global equity and all these different things. And one study they did was the percentage of funds repeating in the top half over two consecutive five-year periods. We look at one five-year period and how many of them performed again the top half over the next five years. And in each category was under 50%, which is like what you'd expect just for a random sample, right?

SPEAKER_01 7:04

So it's like worse than a random sample. Yeah, it's worse than a random sample. Assuming a normal distribution, you'd expect half of them.

SPEAKER_00 7:11

Exactly. So just some very compelling evidence that these actively managed funds that perform well in the past, it just doesn't correlate to performing well again in the future.

SPEAKER_01 7:24

It can, and there's a few of them that do, but you would, like we said before, it's something that you could expect by chance alone. So it's tough to necessarily use that as your data point to point to skill. This could be, again, yourself. We don't have data on individual investors necessarily, but those who pick stocks, I would probably lump you in with the same group of people that are professional money managers, if not meaningfully worse. I think generously looping them in with a similar performance. But so that was looking at the top half. I have some data from Dimensional that looks at the top quartile. So it's like, okay, well, top half, that's a probably a like a pretty big swath. What about like the best of the best? You know, the top 25%. Well, in their findings, this is with U.S. domicile funds. I'm gonna call it pretty similar to what we'd find here in Canada. And again, this is from Dimensional's fund landscape report. Again, they do this every year, but it was updated most recently here for 2025. So they looked at the top quartile funds in a five-year period and how many times they outperformed in the next five-year period. On average, they found that 23% of the time they would be back in the top quartile. So again, it's worse than the random sampling would suggest for that case. So finding maybe, maybe, Sam, let's be generous. Maybe if they get into the top 1%, maybe they continue in the top 1%. Maybe there is something of like the absolute top of the pile here. But boy, the I think the data is pretty compelling to suggest that long-term persistence is maybe just so few and far between. It is tough to rely on past performance as an indicator for what you should own in the future. Again, that's all we're trying to do. We're trying to get returns for the future, not buy yesterday's returns because you can't.

SPEAKER_00 9:15

Yeah, exactly. Evan, I think, as you're saying, there's going to be outliers in any of these data sets. We're looking at kind of the broad trends to give us a sense of what the potential likelihood is that one of these funds that have performed very well in the past continues to perform that well in the future, as far as these actively managed funds go. And yeah, I agree. The the evidence is very compelling that it may happen, but can we rely on it? It doesn't really look like it based on on the amount of evidence there is.

SPEAKER_01 9:43

So if you're using past performance or news headlines or interesting anecdotes from your neighbor that, you know, these this has performed really well. You should totally have some of that in your portfolio. I'm stealing this line. I didn't come up with it, but your your portfolio can start to become a museum of past winners instead of some sort of disciplined investment strategy that has, you know, a little bit of foresight or some evidence-based framework for making a forward-looking decision.

SPEAKER_00 10:13

Yeah, and I mean, I think we don't want to be too, too critical from the standpoint of it's something that draws you in, right? Oh, this fund's performed so well over the last five years. It has that momentum behind it. I want to get my money in there because I feel confident that that will continue. It's almost logical to a certain extent, but just the evidence doesn't bear it out. So there's a lot of people that are implementing that strategy, but the evidence doesn't hold true for it. So there's like a human aspect that makes it feel compelling to kind of go with funds that have done really well. But it's also important to know the evidence doesn't really bear that out as you go forward, as you look to get your future returns and not kind of rely on the past returns. For sure.

SPEAKER_01 10:50

Because, you know, recent winners that feel safe. It seems like that story has been told. It's like, you gotta be here. You got to be part of this action.

SPEAKER_00 10:57

That comes up in the headlines too. And I know we've talked about it previously on the podcast, but headlines are often looking at these funds that are doing well, or maybe they're they're thinking about investing in a kind of more shorter term time frame in lots of cases. And so over more time, you know, five-year periods and things like that, the evidence just doesn't support ongoing returns. But maybe in the very short term, the fund continues to do well, you know?

SPEAKER_01 11:18

Yeah, there's sometimes a momentum factor that's at play, and there's some evidence behind that, but capturing that momentum factor is also a little bit elusive in in terms of reliably doing so. You know, people hate getting left behind. And like that makes sense. Like it's not abnormal to have FOMO, you know, it's not an investment strategy, but it makes sense, right? You you just don't want to be missing out on where the returns have been, and you think that it might continue on forever, and at the same time, doing something like activity trading in and out, and this is coming from advisors, but also individuals, that activity of, you know, oh, we got to be switching over here. This is what's kind of going on right now. We got to be doing this, we got to be doing that. It's like, ah, it feels like we're, you know, we're being engaged, we're doing the right thing with our money instead of sitting on our hands and sure, like if it feels productive, but like I mentioned before, it's like, do you want to start just building a collection of past winners? Or can there be an investment strategy that you can hold on to for a longer period of time that actually gives you a higher degree of success the longer you hold it, as opposed to the other way around? Where with certain strategies, the longer you hold it, the more likely it is to underperform. What about the opposite? Does the opposite exist? I'm setting you up. Yeah.

SPEAKER_00 12:48

Well, yeah, and so that's where one thing we think about Cedar Point Wealth is kind of having this evidence-based investment philosophy, and it gets away from past performance as the indicator of what you want to buy and more the investment philosophy and strategy you want to implement going forward. And so, in many ways, this can be a little bit more difficult for DIY investors or people to implement because it's relying on a wider body of literature and broader evidence rather than the specific fund returns going back. But that's what we rely upon. And it delves into the research about investing and the factors that kind of allow you to maintain those expected returns over time.

SPEAKER_01 13:28

Yeah, for sure. And and part of the the evidence-based approach that isn't appealing is that it's kind of boring, and people have that compulsion to have something interesting happening in the portfolio. And honestly, that's okay. It's just not an evidence-based way of investing. And that's that's okay. You just have to know that though. And so some of the the ways that we we like to to you know look towards the future with investment returns is broadly using diversification. So first thing that we kind of look for if we're gonna get into our version of of what you should do as opposed to chasing past performance, start with diversification. If you can own the haystack instead of finding the needle or dozen needles or whatever in the haystack, you're gonna be in pretty good shape. Now, does that mean that you're gonna own a bunch of losers? Yep. At any given time, something in your portfolio, whether it's you know explicit, maybe you're owning a bunch of different, you know, index funds or different strategies, you know, separated out, or if it's an all-in-one type of product, then it might be happening under the hood. But inevitably, some part of the portfolio is gonna look a bit like a dud. That's also why it doesn't really appeal to a lot of people to stick with it for a long period of time. It's like, ah, this thing isn't really performing very well. And that's the whole point of diversification. Not everything in the portfolio can look good at all times, and that's where the draw towards performance chasing can kind of be because people get uncomfortable with that idea that something that they own isn't doing good currently, so it must be bad, not necessarily, right?

SPEAKER_00 15:11

Yeah, and I think when we're talking about diversification, we're talking about diversification of various kinds. It'd be diversification of location or you know, international diversification. And there's some great data on kind of the variability of which countries do really well your tiers. You kind of want to have that international diversification. We're talking about sector diversification and all these different things. So then you get, as Evan's saying, a representative sample of the index or the haystack. And then there's other ways to kind of optimize from there or potential ways, but that's kind of the broad principle of diversification.

SPEAKER_01 15:41

Yeah. Indexing is probably the easiest way to put a single word around what we're suggesting there, because diversification is not owning 10 Canadian equity funds that all own the same thing. There might be a very small measure of diversification within there. But, you know, if they're all these concentrated 30 to 50 stock portfolios that all own the same thing, it's not diversifying, it's just owning more of the same active funds that are unlikely to stay in the top quartile over the next five-year period, so on and so forth. What you want to do is actually own everything if you can. Then from there, like Sam mentioned, there's a few little optimizations. And what many people, I see this online all the time, is like they're they're comfortable with an indexing strategy, but it's like, yeah, but I want to own a little bit more US because the US has done really well recently. I'd like to get a little bit more NVIDIA in there. And they're already the biggest company on earth, maybe not the move. It's like, ah, went up a whole bunch recently, and there's a good story around. It's like, yeah, that's that all makes sense, but should you lean into that? It's like, okay, well, these are the parts of the market. If you're going to tilt it any one direction to try to get some additional returns beyond what the broad index might provide, factor-based investing is kind of what we subscribe to here. One of the fun companies that we work with to provide those solutions to our clients is called dimensional. They call them dimensions of returns or premiums, things like this. And so there's three primary dimensions of expected returns that they would lean into for their portfolios. Dimensional is just one company, and they're basing this off of publicly available academic research. You can find this research, and so they're not trying to hide anything. It's not proprietary necessarily in terms of the back-end research, but they're just trying to build portfolios that lean into that academic side of things. And the three factors that they primarily tilt their globally diversified portfolios into are size. So those are smaller companies versus large companies, relative price, sometimes we call that value versus growth, and profitability. So high profitability versus low profitability. So over time, all these different time periods are just based on when you can get quality data for that specific factor. But since as far back as you can get for these data sets, the size factor has outperformed in Canada, US developed markets, and emerging markets. Value has outperformed in Canada, US developed and emerging markets, and high profitability versus low profitability has outperformed. Again, those are since inception of the data sets. But something that I found interesting, if we just look at, say, the Canadian market, for example, you can see these factors over a longer period of time. So we've got one, five, ten, and fifteen year periods. This is market beating bills, that just means stocks outperforming bonds. But then small cap beating large cap, value beating growth, and high profitability. Over time, these tend to increase over the longer holding period, right? As opposed to the other way around with a pure actively managed strategy. If we look into the United States, the same data shows up there. The longer you hold it, the more likely you are to outperform. If we're looking at developed markets outside of the US, same thing again. And even in emerging markets here. Over time, these factors have shown, again, it's rarely, once in a while, you have a data set that suggests 100%. That doesn't mean future, that means past, by the way. But there are still periods of time where this isn't the case, right? And so none of these things are guarantees of performance in the future. That's always a caveat we got to have here when we're talking about investments, is that there's no such thing as a guarantee. But all we're trying to do, like we said at the outset, we can't buy yesterday's returns. So how can we tilt the odds in our favor to be able to get tomorrow's returns and get positive returns in such a way that it is reliable to invest in that strategy for us to be able to meet our long-term goals? Here we focus on retirement as the primary goal that many of our clients have. And and so looking at all of this data, I don't feel very compelled to suggest that I should go back and look at the top performing mutual funds, ETFs, individual stocks over the last 10 years and buy more of that. It just it just doesn't play out. It might feel good. You might have that FOMO itch scratched, it might feel like you're making some good activity, but the data just doesn't suggest that that is a reliable way to build a portfolio.

SPEAKER_00 20:19

Yeah, and so that's where the broader data speaks to the small likelihood that the top performing mutual funds will continue to do that, especially if they're actively managed. Whereas we have all this data going back a hundred years in some cases related to some of these factors that you're describing, these dimensions and the frequency in which they've outperformed other kind of factors going forward. And so we're using that evidence, that broader body of data and evidence to make our informed decisions about our investment philosophy.

SPEAKER_01 20:50

Yeah. So to kind of summarize how we suggest that you take a look at investing as opposed to chasing past returns in any one area, start with diversification, of course. Keep your costs in check. That's really, really important. And costs can sometimes be explicit, like the MER is something that people think about, but there's also potentially tax implications. There's trading costs, maybe some currency things, depending on what you're invested in, whatever. But moving things around, again, taxes is probably going to be the big one if you're in non-registered accounts in particular. You need to make sure that you're keeping your costs in the conversation at the very least, so that you're not, you know, basing things around stuff that gets too expensive for you in a literal way or something that's less visible under the hood. So diversification, keeping your costs in check, and making sure that your investments match what you are trying to do, not necessarily just maximize returns at all cost. If your goal is to buy a car next year, investing in something that is a full equity exposure, whatever, that doesn't matter. necessarily make sense. So you want to make sure that your investments are matching your timelines, your objectives, and keeping your risk in line with what is reasonable for those things.

SPEAKER_00 22:11

Yeah. And one thing that kind of came up as we were preparing for this episode is that we were listening to, or we both listened to, an episode of the long-term investor and Cameron Passmore was on it, who's the CEO at PWL Capital here in Canada, and they do the Rational Reminder podcast and things like that. But he had some some really interesting kind of discussion about the current landscape of Canadian financial advising and the finance industry more broadly. And he was talking about from his perspective how Canada is really la lagging behind in this factor-based investing compared to the United States. And there's many more people that are in that active management space and investing in some of those actively managed funds. And so what we're saying here may make sense going with this evidence-based investing, but it's not a given in Canada. And there's kind of room for a lot of Canadian investors to maybe think about a different strategy, like moving away from the actively managed investments. And that's one thing we're trying to implement at Cedar Point Wealth.

SPEAKER_01 23:07

For sure. He he said on the the podcast about 80% of Canadian assets are either in the banking or the insurance only channel. That blew me away. Like that was really really surprising to me. Like I knew that we were kind of lagging behind just in general our counterparts in the United States, even on indexing and even just being aware of investment fees and things like that. But to have that much of Canadian's wealth tied up in institutions that have not shown a particular amount of care for for their clients necessarily and an awareness of of what might be best, that was pretty surprising to me. And just because by the way just because someone's an independent advisor outside of those channels doesn't mean they also you know have a concrete philosophy or anything like that either, right? That that doesn't necessarily guarantee it. But all it says is that there's there's lots of work to do and in terms of getting Canadians investments aligned with what makes sense for them over the long period of time to increase those odds of meeting their goals in the future.

SPEAKER_00 24:10

Yeah so there's two aspects to that process right like one is implementing a more evidence-based strategy for the investments themselves. And the other one is marrying that investment strategy with a personalized financial plan. And I think that's that's one area that he was he was saying I think anecdotally we've we've seen as well where just you know you may be at one of those big institutions and even if you're getting some good service, you know, we had a client that we are a prospective client we talked to recently that had a very good experience at the bank in lots of ways, but there was missing that personalized component of a financial plan as well. So it's really what we try to do and I think makes sense is just marrying that investment strategy with a really personalized financial plan so that you're rowing in the same direction.

SPEAKER_01 24:50

For sure. That's got to be the one two punch for for people optimizing or you know just doing as well as you reasonably can. Optimizing is really tough to do with with without the benefit of hindsight. But you know having a financial plan be the driver for investment decisions I think is is critical. Most Canadians aren't getting that. But anyways if you're listening to this podcast you're watching here on YouTube wherever you find us today I hope that this conversation was valuable. If you have any thoughts feel free to shoot us an email leave a comment if you're on YouTube anything like that. We love to see it and interact there. But yeah we we hope you enjoyed this episode and we will catch you next week on another episode of the Canadian Money Roadmap. Take care. The contents of this podcast do not constitute an offer or solicitation for residents in the United States or any other jurisdiction where Evan Newfeld, Cedar Point Wealth or Sterling Mutuals is not registered or permitted to conduct business. Mutual funds are provided through Sterling Mutuals Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus carefully before investing. Mutual funds are not guaranteed, their values fluctuate frequently and past performance may not be repeated. Financial planning services are provided by Evan Niffeld through Cedar Point Wealth and are not the business of or monitored by Sterling Mutuals Inc.