### Fund Comparison: Avoiding Recency Bias in Investment Returns

Investors should compare funds holistically to avoid being misled by recent performance.

### Rethinking Fund Comparisons: Avoiding Recency Bias and Emphasizing Diversification
* 📈 Many investors focus solely on the S&P 500 due to its **impressive returns**, which have averaged **close to 9% annually** since the financial crisis, vastly outperforming other countries like Switzerland at **just under 4%**.
* ⚠ However, relying solely on past performance can be misleading and may lead to **poor investment choices**, as evidenced by historical periods where the US market **underperformed significantly**.
* 🔍 To make better fund comparisons, it is crucial to **analyze multiple time frames** and **avoid cherry-picking periods**, as this can create a **false sense of security regarding returns**.
* 📊 A more effective method involves plotting **box plots** to visualize the distribution of returns, which helps investors **understand the range of potential outcomes** rather than just focusing on the median return.
* 🌍 Diversification across various countries and investment styles is advisable, as historical data shows that many countries have **similar median returns**, suggesting that recent outperformance may be due to **luck rather than consistent superiority**.
* 💡 For example, while large-cap growth stocks have performed well recently, small-cap value stocks have historically **outperformed over the long term**, highlighting the need for a **balanced approach**.
* 🔒 Additionally, using tools like the Incog app can help protect personal data, emphasizing the **importance of privacy** in today's digital age.
* 📉 Ultimately, understanding the **uncertainty of returns** and considering a **broader investment strategy** can lead to **more informed decisions** and **reduced risk over time**.

People often tell me that they only own an S&P 500 fund. This is because returns have been great, but what if I were to tell you that comparing funds based purely on return can be very dangerous? In this video, I'll suggest a better way

to compare funds and finally we'll apply this approach to some commonly used funds to see which ones look best. This video is sponsored by Incognito, an app that helps you take back control of your data privacy. You can understand the thinking of someone who chooses just the S&P 500.

After all, Warren Buffett likes it and Jack Bogle liked it. And if we look at the returns of the S&P 500 compared with other countries since the financial crisis, well, it's just outperformed every other country hands down. Its return has been close to 9% per year, and the

closest performing country that comes second is Switzerland at just under 4%. So why not go all in on the US? So the way people seem to approach their fund selection when they're comparing returns is they create a table of fund returns ranked by performance, so best performing

at the top like we just saw, worst performing at the bottom, and then they simply choose the fund which is performed best, they invest into that fund, and then guess what happens? It may well underperform. Although that was a 16-year period, I actually cherry-picked

the start time, and that's because after the financial crisis the US has just done very well. Is that always the case? Well, actually no. If we compare the MSCI US index versus MSCI XUS, so that's all of the countries in the developed world,

excluding the US and I take the ratio of those two indices, well when that number goes up, it's because the US is outperforming, and that's what you can see on this graph beside me. Notice how since 2008, yes, the US has done incredibly well.

Well, it's been a blistering performance, and that's been because of a combination of factors: very good earnings growth, very low funding costs, interest rates were pretty much zero over that period, huge amounts of VC capital flowing into tech funds, which blitz-scaled and basically became global companies, but

the US has not been without its financial problems. For example, how about the period between 2002 and 2008? Well, that was when the bubble was in the process of imploding, and then of course, we have the subprime mortgage crisis where the epicenter was in the US. Or how

about the much longer period between the early '70s and 1988? That was another atrocious period for US returns, and a very long one. So what we're going to do in this video is try and avoid that kind of mistake. There is a kind of recency

bias here, and it's much better I think to have a more holistic view of returns, particularly taking into account the uncertainty and also the pure luck of some markets outperforming others, so that we're not beguiled by just one set of returns over a particular period.

Today's video is sponsored by Incog, an app that lets you take back control of your personal data. You may not be aware, but there are companies which can legally sell your personal data, and these are called Data Brokers. Now, personally, I hadn't heard of any of them.

but the only reason I know about them is because I've been using the Incog app in order to stop them using my data. Now this is what the Incog app looks like, and this is my dashboard. So you can very easily see any kind of removal requests

you've got, which have been sent to these data brokers, and at the bottom you can see the activity log. And this is an ongoing process, and you can use more than one email address, so you can see I'm on 20 suppression lists now, and I can

also get a detailed view such that I can see all of the requests which have been sent, and also the status of the request. So if I filtered by high severity score, you can see that CIA, for example, was high severity. Furthermore, it's now been suppressed, and the

associated risks with that data broker are identity theft, spam mail and calls, data leaks, and so on. And if you're into privacy, there's a great blog which explains a lot of the concepts behind Incog, and also the problems of data privacy, which I think many of us simply

aren't aware of. Now for viewers of Pension Craft, there's a special offer such that you can take your personal data back within Incog. Just use the code Pension Craft in the link below, and you can get 60% off an annual plan. So that link

is incog.org. Returns, then the Sterling returns will look better. If you're comparing funds in the UK, you have to be aware of whether they're income funds or accumulation funds. Accumulation funds reinvest the dividends, and that increases their return. So just make sure you're

comparing like with like if you are comparing funds over a fixed period of time later we'll see that's not such a good idea but if you are then make sure the start and end dates are exactly the same sometimes just a few days either

side can change the return also you'll notice that I usually use as long a comparison period as I can less than 5 years is almost useless and that's because you're more likely to get a reasonable estimate of long-term returns over shorter periods of time all sorts

of factors can drive return up and down and then finally if you are comparing funds where you're making a choice between A and B then just make sure they are comparable funds do they have the same degree of risk in them do they have the same style of investing value growth

quality and are the goals of the funds the same so these are all things you should just get out of the way before you actually go the next step and do what I'm about to tell you so what should fund comparisons look like the key thing is that you'll usually be

thinking over some investment horizon be it 5 years 10 years 20 years or more if that's the case then what's helpful is to actually compare funds over that horizon but don't just use one 10-year period try and look at every single

10-year period there's ever been for that fund that way you won't be anchoring on a particular cherry-picked period of time you'll consider every 10-year period And if there is sensitivity to the start and end points which there is for almost all equity funds for example

then this is one way of avoiding that so let's say we've got data on a set of funds going back to 1970 and we're going to be investing over a 10-year period. Well, we'd calculate the return from 1970

to 1980, then 1971 to 1981 and so on and end up with many different 10-year returns for each of the funds. And then what we do is plot something called a box plot, which is just a very handy way of visualizing distributions. So beside

me here, you can see one of those box plots represented horizontally. The vertical white line is the typical case, the median return. 50% of the returns will be above that, 50% will be below it. It's also the 50th percentile. We'll also

consider the best case, so that's the upper whisker as it's called. You can see here and we'll consider the worst case and that's the lower whisker. And then the pink box, which you can see in the middle, contains 50% of the data, so

there's a 50% chance historically you would have ended up in that box, with a quarter of the cases lying above the box and a quarter of the cases lying below the box. And those are the upper and lower tails of the distribution. But the

key thing here is you don't just focus on the median case, the typical case, you also consider the dispersion around that central case. Another way of thinking of that distribution is, which were the lucky returns that were exceptionally large compared to usual and which of the

returns were just unlucky and lower than usual, so those are the upper and lower tails because when we're investing, we might not always be lucky. We could be unlucky, and it's good to know how unlucky we could be based on history so

now let's consider that framework when we're comparing two funds, A and B. Now, in this case, you can see that these two funds are significantly different. Why do I say that? Well, if we look at the medians of those two distributions, their separation is greater than the error

bars for each of the individual distributions such that even if you were really lucky with fund A, your return would have still been lower than if you were unlucky with fund B. So clearly, in this case, you choose fund B. What's more often the case, however, is that the

dispersion between the two, the difference between the medians, isn't very big compared to the error bars. In fact, it's contained within the error bars, in which case there's not a lot to distinguish between those two funds, even though recently one of them might have

been performing very well, for example, such as the US. So how would this approach work in practice? Well, the first step is to visualize those distributions of returns and plot them alongside one another. Box plots are a great way to do that. There are other plots like violin plots,

but the key thing is to compare the distributions and show the uncertainty of the distribution of returns. Secondly, you always have to consider some investment horizon, say 10 years, 20 years, or whatever it is for you, and that's because the uncertainty and return

usually for investors is greater the shorter the investment horizon and this is why we usually choose safer funds over shorter horizons because equity is just so volatile and in the worst case you could lose lots of money and then the third point is that once you

discover the uncertainty around different funds I think you're much more likely to diversify your investments instead of backing just the US say you will diversify across different countries at least I'm hoping that'll be your take on this video so using this analysis let's look at different

countries now this is data from MSCI it goes back to 1969 it's just capital gain it's not total return which is why the UK looks so awful but what really strikes me looking at this graph is if we look at every 10-year period since

1969 there's not a lot to discriminate between a lot of these countries at the top of the table Sweden's been surprisingly good but it's been very similar to the US but notice how in that top eight list of countries if we look at the median return that's the white

line in the center of the box it isn't really very different it lies within the error bars and if you cast your mind back that suggests that outperformance over one 10-year period is likely to be just luck so there isn't a significant

difference between these funds and we should be fairly indifferent between them in which case it does make sense to diversify outside the US and incorporate other countries so buying a developed market index or a global index is probably a better approach than putting everything into the US where if you're

Unlucky, you could lose quite a bit of money, at least over the short term. We can do the same thing with investment styles now. Here, I'm using the Simba data set, which is from a spreadsheet created by the Bogleheads Forum, and this has got

a lot of great historical data. It's annual in return, but it's total return, and it's real return, so it's inflation-adjusted, and the dividends are reinvested. And here, what I've done is I've compared various investment styles in the equity market in the US alongside

some treasury funds. Now, the treasury funds are at the bottom of the table, and certainly for short-duration treasuries, which are effectively money market funds, the returns are significantly lower than they are for equity, and that's true for almost any style of equity. Furthermore,

that difference lies outside the error bars for the equity styles. So, from that, I think it's pretty clear that money market funds underperform equity. So, if you are investing for the long term, for 20 years in this case, then it's certainly worthwhile putting money into

equity rather than money market funds. Now, let's turn to the styles at the top of the table. The one which has been the blowout success since 2008 has been large-cap growth, but surprise, surprise, that's not at the top of the table since

1976. In fact, small-cap value, these are small-cap stocks which are cheap, that's been the best performing style. If we look at the median return, furthermore, if you look at the dispersion, the error bars of large-cap growth, it's got huge dispersion, a lot of uncertainty.

such that in the worst possible return case, if you're unlucky, large cap growth has been very painful indeed unlike small cap value, but what's also visible here I think is that the styles are all quite similar. The only one which seems to be pushing out at the top is small

cap value. So when you compare US strategies, what this analysis shows you is that there isn't a huge difference between these different styles, and this is what makes me a little bit reluctant to pile into a particular style like large cap growth again. Many people that

I speak to tell me that they just buy Magnificent Seven stocks in the US because they're the only show in town and they believe in tech. What this shows to me at least is that that's a mistake and I think diversification across different styles is probably a good idea.

and I wouldn't have a huge tilt to one style or another in case it's one of these unlucky periods. We can also look at Global funds here. I've compared the cumulative return turn of four Global funds. These are all accumulation funds, all Sterling denominated, all fairly

large with large assets under management. However, you can see a difference in return here. The fund at the top from Legal and General seems to be significantly better. So naively you'd look at this graph and think, yeah, I put my money into that best fund, but is that

outperformance just lucky? Well, we can use our analysis to check, and yes, I think in this case it's pretty clear that it is lucky. The error bars are much wider than the differences between the median returns, so there is no significant outperformance here by that

fund This might have just been a lucky period. The one which is borderline underperforming is the Life Strategy 100 fund from Vanguard, and that's because it contains a lot of UK stock. It's got a sixfold overweight for the UK, which over

this period has led to underperformance. But as I always say with global funds, there's not a lot to discriminate between them. Certainly in terms of return, certainly in terms of this analysis, it seems as if they're fungible. You can substitute one for another, so

don't sweat too much about choosing the best global fund. They're all quite similar. I think other criteria should dominate your decision, things like the one with the lowest fee. But it's not just funds that you can compare using this analysis. You can also compare

portfolios now. Tier, the creator of Portfolio Charts, is kind of obsessed with this selective choice of P periods when comparing strategies, so he's done lots of analysis to look at ways to visualize this. So let's try something out using his Portfolio Charts app. We're

going to go for 100% Equity as a strategy, and this is based from the return perspective of someone in the UK. So it uses UK inflation and denominates the returns in Sterling. And as we saw before, the black line you can see here is that strategy versus lots of other

diversified strategies. And you can see that our performance has been unbelievably good. We've crushed the competition, or so it seems. But if we do a similar comparison to the box plots that we saw previously here, we've just got the ranges, that's the horizontal

line and the compounded annual growth rate over the last decade, that's the gray box which you can see here now. For my portfolio, the 100% US S&P 500 tracker, yes that's got the best return over this period. But what if we were unlucky? Well, 

in that case you can see that this strategy, just the US, underperformed all of the other strategies in the worst case. Whereas the second item on the list, although it's got a lower return overall, it's just 5.8% versus 11.8 over the last 

decade, notice the worst case for that, and that's for every 10-year period since 1970, its worst case is just under 4%, which isn't too bad at all. Certainly much better than the US 7% that you got in the worst case for just US Stocks, so 

I hope this has taught you the importance of these starting and ending points when comparing funds. If you simply buy something like gold or US Stocks because they've performed well over the last decade, just bear in mind that that could have been due to luck, and you 

should always consider the uncertainty of that return. If you have more historical data now, don't forget our offer from Incognito. You can take back control of your personal data just by using the code 'pension P S O N', and you can also use the link below 

incognito/pension, and that way you'll get 60% off your annual subscription. And of course, there'll be a link in the description below. And as always, thank you for listening. 

Should You Avoid The S&P 500?

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

Before starting PensionCraft, I worked in investment banking as a strategist and I was a frequent contributor on CNBC and Bloomberg TV. I have written two books about finance and investment: one for professional investors and one that explains how to buy and sell volatility using exchange-traded products.

I publish a new video on YouTube every Saturday and you can join me for a live Q&A on the 1st Thursday of every month at 7pm UK time.

If you want to learn how to become a better investor then why not join our friendly membership at pensioncraft.com?


PensionCraft

The Danger of Comparing Funds Solely on Returns

Many investors only own S&P 500 funds due to their strong returns.

Comparing funds based solely on returns is risky.

S&P 500's post-financial crisis outperformance is highlighted.

Common fund selection approach: ranking by performance and choosing the top performer.

The risk of cherry-picking data and recency bias is emphasized.

Analyzing US Market Performance Over Time

Comparison of MSCI US index vs. MSCI XUS index to show US outperformance since 2008.

Factors contributing to US market's strong performance since 2008 are discussed.

Periods of poor US market performance (2002-2008, early 70s-1988) are mentioned.

The importance of a holistic view of returns, considering uncertainty and luck, is stressed.

Considering investment horizons (5, 10, 20 years or more) when comparing funds.

Analyzing every single period within the chosen horizon to avoid anchoring on a specific period.

Using box plots to visualize distributions of 10-year returns for each fund.

Considering both lucky and unlucky returns (upper and lower tails of the distribution).

Comparing funds A and B, highlighting the importance of median return and dispersion.

If the difference between medians is within the error bars, there's little to distinguish between funds.

Visualizing return distributions using box plots or violin plots to show uncertainty.

Considering investment horizon as uncertainty increases with shorter horizons.

Diversification is encouraged due to the uncertainty around different funds.

Applying the Analysis to Different Investments

Analyzing returns of different countries using MSCI data since 1969.

Comparing US investment styles (equity vs. treasury funds) using Simba data set.

Analyzing the performance of different investment styles (large-cap growth, small-cap value, etc.).

Comparing cumulative returns of four global funds, highlighting the role of luck in outperformance.

Comparing portfolios using Portfolio Charts app, emphasizing the importance of considering worst-case scenarios.