Persistent chasing of past performance when selecting mutual funds

A TFI research project by Leonardo Weiss-Cohen, Philip W.S. Newall & Peter Ayton
Posted on December 10, 2019

“Persistent chasing of past performance when selecting mutual funds” is one of the short-term research projects supported by the Think Forward Initiative.

As savings rates decrease, people start to look for other forms of wealth accumulation, such as investing. But how do people know what funds they should invest in? Investors often choose mutual funds based on its past performance. However, the investment fund’s fee has proven to be a better indicator of future return. Low fee funds, compared to high fee funds, yield higher returns and is the recommended strategy to achieve long-term gains.

Researchers Leonardo Weiss-Cohen, Philip Newall and Peter Ayton studied how (in)experienced investors select mutual funds and how their investment decisions could be improved. Unique to their research is the realistic simulation of investment decisions. Instead of focusing on one-off decisions, the researchers study repeated fund choices.

Which individuals are most at risk of choosing the suboptimal high-fee mutual funds? And what disclaimer helps investors to select the low-fee fund instead?

Download the research report below and find out!


Resisting the lure of past performance: consumer protection in the mutual fund sector

Investing in mutual funds is the most common way for people to join financial markets. Almost half of all American households do so, paying a management fee to the fund provider. Those fees equal 0.55% of assets per year on average, which means as much as US$100 billion in total.

Despite being warned by regulatory-mandated disclaimers that past performance does not predict future returns (Barber, Odean, & Zheng, 2005; Choi, Laibson, & Madrian, 2010; Pontari, Stanaland, & Smythe, 2009), investors tend to pick their mutual funds based on past performance. That’s a poor fund selection strategy: long-term analyses have confirmed that mutual funds cannot consistently return better-than-average performance (Carhart, 1997; Jain & Wu, 2000; Malkiel, 1995).

Any individual over-performance can mostly be attributed to luck (Mercer, Palmiter, & Taha, 2010), so investors would receive considerably better returns if they picked mutual funds with lower fees (Carhart, 1997; Haslem, Baker, & Smith, 2008). Still, most investors seem to disregard fees when choosing funds (Fisch & Wilkinson-Ryan, 2014; Wilcox, 2003).

The experiments

The relationship between fees and performance is an interesting one. In our two experiments, we tested a new paradigm with repeated decisions and randomly generated fund returns. Would repeated experience, over a period of 60 months, help our 996 participants reduce the chasing of past performance, as they learned how the task’s ecological design operated?

Participants were asked to choose between two similar index-tracking funds, one low-fee fund and one high-fee fund. Each trial represented one month of investment based on real historical market returns of the S&P 500. Apart from the difference in fees, the returns of the two funds were generated dynamically by the same underlying stochastic process: the index return plus a noise component.

Because the noise had a mean of zero, we ensured that both funds had the same average gross performance (before fees). As a result, chasing past performance was a futile, costly strategy. Our participants would only maximize their earnings if they consistently chose the low-fee fund, as is also true when choosing index funds in the real world. They were financially compensated based on the performance of the funds they chose, and we observed that those who had picked the low-fee fund earned more money more frequently than those who had gone for the high-fee fund.

Our manipulation was a disclaimer which was presented (or not) before participants started selecting funds. In the no-disclaimer condition, participants saw this neutral message: “Please click the button below when you are ready to start the task.” In the standard condition, participants saw the well-known disclaimer: “Past performance does not guarantee future results.”

In the social disclaimer condition, however, participants were presented a very different message: “Some people invest based on past performance, but funds with low fees have the highest future results.” This is a social manipulation first used in Newall and Parker (2018). The aim of this manipulation was to make the futility of chasing past returns more salient. We expected our new social disclaimer to improve performance, nudging our participants to go for the low-fee fund more often, earning more money.


Our participants consistently and persistently chased past performance across both experiments. In Experiment 1, experienced investors (N = 400) were no better at minimizing fees given a standard regulatory discloser than when given no disclosure at all, choosing the low-fee fund as frequently. In

Experiment 2, non-investors without prior experience (N = 596), again were not helped by a standard regulatory disclosure. However, they were sensitive to the social disclaimer that highlighted the benefits of low-fee mutual funds.

While the standard regulatory disclaimer performed no better than no disclaimer in most cases, it actually created a perverse effect of shifting low financial-literacy individuals more towards the high-fee mutual fund. Financial literacy moderated the results found here, with participants with higher financial literacy choosing the low-fee fund more often than participants with low financial literacy.


When choosing between two similar index-tracking mutual funds with different fees, our participants persistently chased past performance instead of minimizing fees. These results have important implications for consumer protection in the mutual fund sector, revealing the ineffectiveness of the current advice that “past performance does not guarantee future results”, and providing support for a slightly different but considerably more effective statement that “some people invest based on past performance, but funds with low fees have the highest future results.”

We showed that a social disclaimer can be significantly better than no disclaimer at all, or than the standard disclaimer currently used throughout the industry. The social disclaimer led to more frequent selections from the low-fee fund throughout, and also led to flatter relationships between selections and previous returns, reducing the chasing of past performance. In comparison, the standard regulatory-mandated disclaimer on past performance did not actually help our participants: it even decreased the performance of individuals with lower financial literacy and no prior investments.

This relationship was moderated by an interaction between financial literacy and prior investments. Individuals with lower financial literacy performed worse than individuals with higher financial literacy. However, it seems that having made prior investments in stocks helped those individuals with higher financial literacy, but was detrimental to individuals with lower financial literacy. It appears that a combination between financial literacy (which can be learned in theory alone) and prior experience with financial markets (which can only be learned with direct personal experience) is the best combination to help individuals invest more smartly.

In some aspects of life, individuals are good at finding the best deals, but sometimes they aren’t. Research in health insurance, for instance, has shown that individuals often select fully dominated products, which are more expensive and of lower quality (Bhargava, Loewenstein, & Sydnor, 2017). In mutual fund selection, individuals often disregard fees, which history has shown to be the best determinant of future performance in a noisy environment.

Attempts to make fees and costs more salient via regulation does not seem to have helped. In our paradigm, the fees were prominently displayed throughout. There is evidence that investors are not as mindful of recurring annual fees as they are of upfront buying costs (Houge & Wellman, 2007). An on-going shift from high up-front charges to smaller but recurring annual charges might help hide the expenses in the volatility of market returns. This creates a renewed importance of highlighting the deterioration of returns caused by expenses.


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