Excerpted from Common Sense on Mutual Funds by John C. Bogle, pages 96-98

Despite Rule 3, there is an important role that past performance can play in helping you to make your fund selections. While you should disregard a single aggregate number showing a fund's past long-term return, you can learn a great deal by studying the nature of its past returns. Above all, look for consistency. When I evaluate mutual funds (and I have looked carefully at many hundreds of them during my long career), I like to look at a fund's ranking among other funds with similar policies and objectives (i.e., I compare a large-cap value fund with other large-cap value funds, a small-cap growth fund with other comparable funds, and so on.)

Morningstar Mutual Funds makes these comparisons easy. It shows, in a simple chart, whether a fund was in the first, second, third, or fourth quartile of its group during each of the preceding 12 years. The chart gives a fair reflection of both the consistency of a fund's policies and the relative success of its managers. For a fund to earn a top performance evaluation, it should have, in my opinion, at least six to nine years in the top two quartiles and no more than one or two years in the bottom quartile. I would normally reject funds with four or five years in the bottom quartile, even if offset by the same number in the top quartile. Figure 4.4 provides two examples of real-world funds that reflect the standards I've set forth.

The good fund was in the top half in 10 years, in the bottom quartile only once, and in the third quartile once. The bad fund was in the top half six times and in the bottom quartile four times, and it had two third-quartile appearances. I've taken the liberty of also showing in Figure 4.4 how an index fund stacks up. Remarkably - and I caution you not to expect the pattern to recur quite this favorably in the future - the S&P 500 index fund earned top-half ranking fully 11 times, without once finding its way into the bottom quartile. In any event, consistency is a virtue for a mutual fund. Intelligent investors will want to give it heavy weight in the fund selection process.

YAHOO! FINANCE TIP Yahoo! Finance reports a mutual fund's performance history on its performance page. For an example, see VFINX's performance page.

In using the word performance, I am not limiting my interest solely to return. Risk is a crucial element in investing. I especially like to know a fund's Morningstar risk rating - based on a fund's returns in the months in which it underperformed the risk-free U.S. Treasury bill - relative to its peers with similar objectives and policies, and relative to all equity funds. That rating serves as a rough guide to how much relative risk the fund typically assumes. There is a difference! Indeed, the risk of the average large-cap value fund (22 percent below average) has carried only half of the risk of its small-cap growth fund counterpart (93 percent above average). Table 4.3 compared the Morningstar risk ratings for the nine basic investment styles. Risk matters. For while future fund returns are utterly unpredictable, large differences in relative risk among funds have proven to be highly predictable.


Risk - however measured and however elusive a concept, except in retrospect - should be given the most careful consideration by the intelligent investor. Markets, no matter what you may have come to think, do not always rise!

YAHOO! FINANCE TIP Yahoo! Finance reports a mutual fund's risk statistics on its risk page. For an example, see VFINX's risk page.