Excerpted from Common Sense on Mutual Funds by John C. Bogle, pages 94-96

My third rule has to do with the first element that catches the eye of most investors, whether experienced or novice: the fund's past track record. (The analogy to a horse race implied by the phrase track record is presumably unintentional!) But track records, helpful as they may be in appraising how thoroughbred horses will run (and they may not be very effective there either) are usually hopelessly misleading in appraising how money managers will perform. There is no way under the sun to forecast a fund's future absolute returns based on its past record. Even if someone could accurately forecast the future absolute returns the stock market will deliver - no mean task! - there is no way to forecast the future returns that an individual mutual fund will deliver relative to the market. The only exception would be the relative returns of index funds.

Now, I must contradict myself ever so slightly. Two highly probable, if not certain, forecasts can be made:

1. Funds with unusually high expenses are likely to underperform appropriate market indexes.

2. Funds with past relative returns that have been substantially superior to the returns of an appropriate market index will regress toward, and usually below, the market mean over time.

Reversion to the mean - the law of gravity in the financial markets that causes funds that are up to go down, and funds that are down to go up - is clear, quantifiable, and apparently almost inevitable. (I'll talk more about reversion to the mean, and the implications it holds for your portfolio selections, in Chapter 10.)

The two studies summarized in Table 4.2 show the deteriorating returns of top-quartile growth and growth and income funds relative to the market return over consecutive decades, as 99 percent of those funds reverted toward the mean. Note that only one fund was an exception to the rule. That fund - which ruled the world during both the 1970s and the 1980s and became the largest fund in the industry - reverted magnificently to the mean during the 1990s. Sometimes, reversion to the mean requires patience!

The mutual fund industry is well aware that nearly all top performers eventually lose their edge. Why fund sponsors persist in the vigorous expensive, and finally misleading advertising and promotion of their most successful past performers defies all reason - except one. Promotion of funds with high past returns brings in lots of new money from investors, and lots of new fees to the adviser. Managers are highly rewarded for their transitory past success. Have you ever seen the promotion of a fund that has had either a low absolute return or a subpar relative return? (During the past 15 years, 95 percent of all equity funds have failed to beat the Standard & Poor's 500 Stock Index.) Promotions of funds based on past performance lead you in the wrong direction. Ignore them.