Why Last Year’s Winner Is Rarely Next Year’s

Chasing the best-performing ETFs means buying funds because they have recently gone up the most. It feels logical, but it usually backfires. By the time a fund tops the performance tables, much of its gain has already happened, its holdings are often expensive, and the investors piling in tend to arrive just before the returns cool or reverse.

Studies of fund performance have repeatedly found that very few top-performing funds stay at the top, and that the average investor earns less than the funds they own because they buy after strong runs and sell after falls. The real danger is not one bad purchase, but a habit of buying high and selling low that quietly eats into returns for years.

Don’t let a lack of investment knowledge become the most expensive mistake you ever make. FRC’s three ETF programmes, ETF Investing for Beginners, ETF Investing Strategies and Advanced ETF Investing, teach you to judge an ETF on what it owns, what it costs and how it fits your plan, not on last year’s headline return. They are written in plain English, need no finance degree, and are open to everyone.

This guide is part of FRC’s complete step-by-step guide to investing in ETFs. It explains why performance chasing is so tempting, why it so often goes wrong, and what to do instead.

Why Top Performers Rarely Stay on Top

The ETF that tops the performance table one year is often not even close the next. Leadership in markets rotates. A sector or theme that soars one year can fall the next, as investors move on, valuations stretch too far or conditions change.

Fund research firms such as S&P Dow Jones Indices publish regular studies on how often top-performing funds stay at the top. Their findings have been consistent for years: only a small fraction of funds that rank in the top group in one period stay there in the following periods.

The reason is simple. Strong past returns often reflect conditions that have already played out. A fund that has doubled is, by definition, more expensive than it was, and the factors that drove its gains are already priced in.

Investors call this mean reversion: unusually strong returns tend to be followed by more ordinary, or weaker, ones as prices drift back towards their long-term trend. It does not happen on a timetable, but it happens often enough that a spectacular year should make you more cautious, not less.

There is also outcome bias, the tendency to treat a good result as proof of a good decision. A fund that soared may have been lucky, or simply in the right sector at the right time, rather than run by a manager or strategy with a lasting edge.

Before you invest your first dollar, make sure you understand the investment. ETF Investing for Beginners shows you how to look past headline returns to what a fund actually owns and costs.

How Performance Chasing Destroys Returns

Investors who chase performance tend to buy after a fund has risen sharply and sell after it has fallen. That is the exact opposite of buying low and selling high.

The pattern usually unfolds in three stages. First comes the fear-of-missing-out purchase, after a fund has jumped 40% or 50% and the headlines are everywhere. Then comes the disappointment, as the cycle turns and the fund falls or lags. Finally comes the frustrated sale near the bottom, often just before the fund recovers, with the money moved into the next recent winner.

Morningstar’s annual studies of investor returns have repeatedly found that the average dollar invested in funds earns less than the funds themselves report, in several studies by around one percentage point a year. The gap comes largely from poorly timed purchases and sales. The funds did fine; the investors’ timing did not.

The gap is usually widest in the most volatile and fashionable funds, where money floods in after big gains and flows out after big losses. Steady, broad, low-cost funds tend to show the smallest gaps, because investors are less tempted to trade them.

One percentage point a year sounds small, but compounded over decades it can cost a large share of your final wealth. FRC’s guide to 25 ways to cut the cost of investing in ETFs shows how to stop small annual drags adding up.

A Simple Example of Buying High

Imagine a thematic ETF that rises 80% in a year and becomes the talk of social media. An investor who missed the rise puts $10,000 into it at the top, expecting more of the same.

The following year, the theme falls out of favour and the fund drops 40%. The $10,000 is now worth $6,000. To get back to where they started, the fund now needs to rise by about 67%, not 40%, because losses are always measured from a smaller base.

If the investor then sells in frustration and moves to the next hot fund, the loss is locked in and the cycle starts again. The fund’s long-term record may still look impressive; the investor’s own result does not.

Sector Leadership Keeps Changing

The sectors that lead the market change all the time. In 2020, energy was the worst-performing sector of the S&P 500. In 2021 and again in 2022, it was the best.

Technology tells the opposite story. It was one of the strongest sectors in 2020 and one of the weakest in 2022, when rising interest rates hit fast-growing companies hardest. An investor who bought the previous year’s winning sector each January would have repeatedly been on the wrong side of these turns.

Charts that rank asset classes and sectors by their return each year often look like a patchwork quilt, with leaders and laggards swapping places from one year to the next. That pattern is the strongest argument for owning a broad mix rather than betting on last year’s leader.

The Thematic ETF Trap

Thematic ETFs focus on a story: artificial intelligence, clean energy, cannabis, space, genomics, defence or whatever is capturing attention. New thematic funds tend to launch after a theme has already become popular and prices have already risen.

That timing works against investors. Academic research on specialised ETFs has found that funds launched to ride popular themes have tended to perform poorly after launch, because they arrive when the excitement, and the prices, are near their peak.

The pattern played out clearly in the early 2020s. Several high-profile innovation and clean energy funds posted spectacular returns in 2020, attracted billions of dollars of new money, and then fell sharply in the years that followed. Many investors who bought after the headlines lost money even though the funds had made huge gains for those who were there earlier.

Many thematic funds also never reach the size they need to survive. Small ETFs that fail to attract enough assets are often closed, forcing investors to sell, possibly at a loss and possibly with a tax bill, then find somewhere else for their money.

FRC’s guide on how to choose an ETF sets out what to check before buying any fund, especially one built around a popular theme.

Hidden Risks Behind Spectacular Returns

A fund rarely beats the market by a wide margin without taking extra risk. That risk is often invisible during the good times and painfully obvious afterwards.

Top performers are frequently concentrated in a small number of companies or one sector. Some use leverage, which magnifies gains on the way up and losses on the way down. Others hold small, volatile companies that can fall far further than the market.

High returns can also come with high costs. Thematic, active and leveraged ETFs usually charge far more than broad index funds, and those fees keep coming whether the fund is winning or losing.

Understand the risks, costs and mechanics before making your investment decisions. ETF Investing Strategies teaches you how to read concentration, leverage and cost before a fund ever reaches your portfolio.

Why Chasing Is So Tempting

Performance chasing is not a sign of foolishness. It is a deeply human response. When a fund has gone up, it feels proven and safe, and the fear of missing out pushes people to act.

Recency bias makes recent events feel more important than they are, so a strong year feels like a reliable pattern. Financial news amplifies the effect, with headlines that spotlight the biggest winners and rarely revisit them after they fall.

Social media adds a newer pressure. Posts showing huge gains from a single fund spread quickly, while losses are rarely shared. Some online promoters are paid to feature products, and regulators including FINRA have warned investors to be cautious about investment tips from influencers. FRC’s guide on how to avoid investment scams covers the warning signs.

There is also the comfort of the crowd. Buying what everyone else is buying feels less risky than holding something unfashionable, even when the crowd is paying a high price for yesterday’s success.

What Chasing Costs Beyond Poor Timing

Switching between funds costs money even when the timing works out. Every trade adds a bid-ask spread, and specialist ETFs often have wider spreads than broad funds.

In a taxable account, selling a fund that has risen creates a capital gains bill, and selling within a year means paying tax at higher short-term rates. Frequent switching can turn a reasonable pre-tax return into a disappointing after-tax one. FRC’s guide to how ETFs are taxed in the United States explains the rules.

There is also a portfolio cost. Constantly adding the latest winner tends to leave investors with a jumble of overlapping funds, concentrated in whatever has been fashionable. FRC’s guide on how to check ETF overlap shows how to spot it.

Signs You Might Be Chasing Performance

You first heard about the fund because of how much it has gone up, not because of what it owns. You are buying it mainly because you feel you have missed out.

You are selling a fund you were happy with only because something else has done better recently. Your portfolio has grown into a long list of funds, each added after a strong run.

You check performance rankings more often than you review your own goals. If several of these sound familiar, it may be time to step back and rebuild your approach around a plan rather than the latest leaderboard.

What to Do Instead

Start with a plan. Decide what you are investing for, how long you have and how much risk you can live with, then choose a mix of investments that fits. A clear plan gives you a reason to say no to the fund of the moment.

Build the core of your portfolio from broad, low-cost index ETFs. They will never top the performance tables, but they will never be at the bottom either, and they capture the return of the market as a whole at very little cost. FRC’s guide to the three-fund portfolio shows how simple a sound portfolio can be.

If you want to back a theme or sector you believe in, keep it to a small part of your portfolio, sized so that a large fall would not derail your plans. FRC’s guide to the core and satellite ETF portfolio explains how.

Stop sorting funds by their one-year return. Use a repeatable checklist instead: what the fund owns, how its index is built, what it costs, how liquid it is and how tight its spread is. Those traits tell you far more about what you are buying than last year’s headline number.

Automate where you can. Regular monthly investments into the same core funds remove the temptation to time your entries, and a set schedule makes it easier to ignore whatever is trending this week.

Rebalance on a schedule. Rebalancing means trimming what has risen and adding to what has fallen, which is the disciplined opposite of performance chasing. FRC’s guide on how to rebalance an ETF portfolio shows how.

Questions to Ask Before Buying a Top Performer

What does the fund actually own, and how concentrated is it? Why has it done so well, and are those reasons likely to continue or already reflected in the price?

How did it perform in falling markets, not just rising ones? What does it cost each year, and how wide is its spread?

How would it fit with what you already own, and would it add something new or just more of the same? And finally, would you still want to own it if it fell 40% next year?

If you cannot answer these questions with confidence, the fund’s past return is not a reason to buy it.

How to Read Performance Figures Properly

Look at performance over several periods, such as one, three, five and ten years, rather than the most recent year alone. A single spectacular year can make a fund’s longer-term record look far better than it is.

Compare a fund with a suitable benchmark, not with the market in general. A technology fund that beat the S&P 500 in a strong year for technology has not necessarily done well for its category.

Check total return, which includes dividends, and look at how deep the fund’s worst falls have been. A fund that rose 60% but has fallen 50% from its peak in the past may be far riskier than its average return suggests.

Check how long the fund has existed, too. A record of only two or three years says little about how it would handle a full market cycle, including a deep and lasting fall. Remember that every fund document carries the same warning for a reason: past performance is not a reliable guide to future returns.

Why risk thousands of dollars learning through mistakes when you can learn before investing? Advanced ETF Investing goes deeper into portfolio construction, risk analysis and the discipline that separates successful investors from trend followers.

Common Questions

Is it a good idea to buy the best-performing ETF? Not on its own. Strong past performance often reflects gains that have already happened, and top performers frequently fall back. Judge a fund on what it owns, what it costs and how it fits your plan.

Why do top-performing ETFs often disappoint? Their gains often come from conditions that have already played out, such as a sector boom. By the time they top the tables, prices may be stretched, and the money that floods in tends to arrive near the peak.

What is performance chasing? Performance chasing is buying investments because they have recently risen strongly, often while selling those that have fallen. It tends to lead to buying high and selling low.

How much does performance chasing cost investors? Studies of investor returns have found that the average investor earns less than the funds they own, in several studies by around one percentage point a year, largely because of poorly timed buying and selling.

Are thematic ETFs a bad investment? Not necessarily, but they carry extra risks. They are often concentrated, more expensive and launched after a theme has already become popular. If you invest in one, keep it to a small part of your portfolio.

What should I invest in instead of chasing performance? Many long-term investors build the core of their portfolio from broad, low-cost index ETFs that match their goals, then rebalance regularly rather than switching to whatever has recently done best.

Can past performance tell you anything useful? Yes, but not about future returns. Past performance can show how a fund behaves in different markets, how deep its falls have been and how closely it tracks its index. Use it to understand risk, not to predict the next winner.

What does Warren Buffett say about chasing performance? Buffett has long argued that most investors are better served by a low-cost S&P 500 index fund than by trying to pick winners. He famously won a ten-year bet that an S&P 500 index fund would beat a selection of hedge funds, and has said his own estate instructions put most of the money for his wife into such a fund.

Do 90% of investors lose money? That figure is usually quoted about short-term traders, such as day traders, where studies have found most lose money. Long-term investors holding broad, diversified funds have historically done far better, though returns are never guaranteed. Frequent trading and performance chasing are what push investors towards the losing side.

What is the biggest risk with ETFs? For most investors, the biggest risks are market risk, the chance that the whole market falls, and behaviour, buying and selling at the wrong times. Chasing performance combines both, by concentrating money in whatever has risen most just before it falls.

Should I sell an ETF because it has performed badly? Not automatically. A broad fund that has fallen with the market may simply be doing its job, and selling locks in the loss. Review whether the fund still fits your plan rather than reacting to its recent return.

Your Portfolio Deserves an Educated Investor

There will always be a fund at the top of the tables, and there will always be someone telling you that you have missed out. The investors who build lasting wealth are rarely the ones who chased it.

Don’t pay the market to teach you expensive lessons. FRC’s three progressive ETF programmes take you from understanding what you own, through building a disciplined strategy, to managing a portfolio that does not depend on guessing the next winner. FRC’s programmes and memberships are open to everyone, whether you are investing $500 or $500,000.

Invest in understanding the market before investing in the market itself. The best-performing investor is usually the most patient one.