When it comes to investing, we’re all drawn to the same thing: results.

We don’t get into investing for the sake of it. We want investing to take us somewhere. To put us in a position that we can’t reach from a regular savings account.

So when you consider the different investing options, it’s hard to ignore the ETFs that have produced killer returns in the last few years. After all, the numbers are right there, tempting you – almost telling you: “pick me, pick me!”

So why not just invest in the best-performing funds you can find? Well, there’s a little more to it than that. And that’s exactly what we’re going to unpack in this article.

Let’s dive in.

The reality of the “best performing” funds

Looking at fund performance is often a bit misleading, but not in the way you think. OK, so performance is not an illusion by itself, but the way we look at it is.

When many people look at a fund and say it’s a "strong performer”, they’re only half right. What they really mean is that "it has performed well up until this point over the time period I’m looking at."

I’m not being pedantic – this is extremely important. Think about it carefully. One suggests an ongoing trend that is currently taking place and continuing (unprovable), while the other is purely backward-looking based on data (fact).

The truth is, the performance of shares, ETFs and markets are always a snapshot in time. It reflects what has happened, but tells us nothing of whether that will continue or not.

The issue arises because we assume that something which has been performing well will continue to do so. The academics call this recency bias. We overweight recent events because they’re fresh in our mind and extrapolate that out into the future.

But history shows us that markets move in cycles, and nothing stays on top forever. So, unfortunately, the "best" is only ever true in hindsight.

Our desire to find the big winners

Let's break this down a little further. If there were simply a permanently "best" fund, everyone would just invest in that. Other investments would be a waste of time.

I think, instinctively, we know this is the case, due to the inevitable uncertainty involved.

Strategies and funds don’t have strong performance in a vacuum. That performance impacts investor behaviour, as does poor performance. So what happens?

A rush of money continues to flow into the best recent performers, pushing up prices further. You can look at this two ways: it brings forward future returns. It also eats away at outperformance. The same principle applies to companies, sectors, markets, and even property.

It’s completely natural to be drawn to performance because that’s what we’re after. We’re hardwired to look at what’s successful and want to get in on a good thing.

Maybe it’s a specific market like the US, or it’s a popular theme – see my article on thematic ETFs .

And with investing, it seems like the logical thing to do. But while looking at history can definitely give us useful insights, it's not a crystal ball. Due to the market being priced everyday, it simply doesn’t work like that.

Chasing high-performing ETFs can result in you taking more risk than you need to, in the hopes of higher returns. Performance-chasing implies concentration, since only a few strategies will outperform during a given period. That can pay off handsomely if it works, but the odds aren’t great, and it can leave you disappointed if it doesn’t.

Let’s say a diversified portfolio will provide 8% annual returns over a 10-year period. Would you trade this for the chance of either 16% per year, or 0% per year? Does that seem like a good tradeoff?

This isn’t a bad example. If you get it right, you might earn double returns. If you get it wrong (arguably more likely), you’ll end up with poor returns, or maybe even negative returns.

Some people would say yes, and opt for the get rich or die trying approach. They’ll point to a strategy that has delivered great returns over the last decade or so and say: “look how reliable this fund is.”

But just because something has outperformed well in the recent decade, doesn’t mean it will continue. Now, it can , sure. But we shouldn’t bank on it. In fact, the opposite is often true. The reason for that lies in the market’s natural cycles. Enter: mean reversion.

The See-Saw Effect of mean reversion

Mean reversion is a little bit like a very slow moving see-saw, with one person each side of a similar size.

Essentially, over time, there’s a tendency for extreme performance (either up or down) to move back toward the average. In other words, the best-performing funds today might just be tomorrow’s underperformers.

I think we know this to be true, but we don’t want to believe it. We want to believe we’ve found a winning strategy that beats all the others.

As a side note, the irony of index funds is that they capture the market average performance, but investing in this manner gives you above average performance. How? Because you beat the huge number of people trying to do better than average, who, as a collective , cannot achieve it.

Stepping back to see the cycles

Quite often people will point to the US market as a strong outperformer. This has been the case for some time now.

In the 2010s decade, the US tech boom saw American shares significantly outperform Aussie shares (and the rest of the world). But if we go back to the previous decade – the 2000s – our mining boom saw the ASX demolish the US. In fact, it was an atrocious decade for the US.

If we zoom back further – to the year 1900 – both markets have delivered similar long-term returns (chart below). Interestingly, both have been in the few top performing markets in the world.

As the following chart shows, with the green and red shading, the cycles of outperformance between Australia and US shares shifts over time, often from one decade to the next.

Source: Owen Analytics

This isn’t unusual. Property markets do this too.

For example, house prices in Sydney and Melbourne property prices soared between 2012 and 2017, while Perth, Brisbane and Adelaide did very little.

As usual, there were all kinds of narratives to explain why this ‘two speed market’ happened, and why it would continue for the foreseeable future.

Since then, the opposite has happened. For the last five years or so, Perth, Brisbane and Adelaide have been absolutely flying, with Sydney and Melbourne performing comparatively poorly.

Again, we see recency bias and mean reversion at play. None of this is to say that trends can’t continue for a very long time. The point is that we shouldn’t delude ourselves into thinking we know the future, or that we’ve found a magical asset that will outperform forever.

Eventually, price differences between markets, sectors, and asset classes stop making sense relative to one another. That’s when people wake up and realise: “Wow, asset A is getting fairly expensive, but asset B is actually pretty cheap.”

OK, so if we recognise this ‘performance chasing’ behaviour is a trap, how can we combat it?

How to beat performance-chasing

Look, you might never cure yourself of performance chasing – I think we all get enticed from time to time. But here’s a few practical steps to keep you on the straight and narrow (jeez, it sounds like an addiction doesn’t it?).

Don’t panic-sell underperformers

If a fund or asset in your portfolio isn’t doing well, resist the urge to sell it just because of that. Poor periods are inevitable, with all funds and asset classes. Quite often, adding to recent underperformers – especially if they’re long-term sensible choices – can reap greater gains when mean reversion takes place.

On a personal note, I held onto my Perth properties despite their poor performance because I figured things would change at some point. And that’s exactly what happened – so the patience paid off, even though it was painful at the time.

Build your portfolio for long-term quality

This includes low fees, broad diversification, multiple markets, and simplicity in running the portfolio. These factors can go a very long way to ensuring a solid outcome. Even if you don’t end up with the highest possible returns, you’re putting the probabilities on your side that you won’t end up with a poor result due to betting on one theme continuing. Do you want a portfolio you can simply buy and hold, or one you need to adjust if/when trends change?

Combat FOMO

Fear of missing out (FOMO) is one of the biggest drivers of performance-chasing. Remind yourself that no single investment or fund will make or break your financial future. You don’t need to find the biggest winners to build wealth. Sure, it’ll be great if you do, but there’s certainly no need to take the additional risks necessary to get outsized returns. Slow and steady wins the race, and personal finance beats performance in almost every case.

The case for diversification

I know, diversification is the investing equivalent of eating your vegetables. But the reality is, trying to chase the best performers isn’t exactly a reliable strategy, so diversification is the next smartest move.

There are several benefits for doing this.

Balancing markets

The US is heavily skewed toward tech, while Australia leans on resources and financials. By investing in both (and globally), you spread your bets across different strengths and risks.

Over time, this balance tends to smooth out your returns, while allowing you to invest in one market when it’s down (and therefore cheaper) than another. You can spread yourself between asset classes too.

Nobody knows the future

The US has dominated since the GFC, but how do we know that will continue? There are arguments on both sides. You might be convinced the US will keep outpacing global markets, but what if you’re wrong? What if everyone just decides valuations are too high, and company profits start slipping?

That could lead to a painful re-rating and a decade of low returns. Yes, a diversified investor is affected too, but to a lesser extent – that’s the whole point.

Think of it like a buffet. Instead of loading your plate with just one dish, you pick a few solid choices. You might miss having a whole plate of the “absolute best dish,” but you’re also avoiding the case that it turns out to be a bad choice.

TL;DR Lessons from this article

Past performance isn’t future certainty. Chasing top-performing funds often means you’re buying into something that’s already highly valued.

Mean reversion matters. Sectors and markets that outperform in one period, may underperform the next. Markets have a way of evening themselves out over time.

Avoid FOMO. Fear of missing out often drives bad investment decisions, leading to unnecessary risks. Make sure your strategy is logical and reasonable, rather than overexcited based on recent history.

Diversification is key. Balancing between assets, markets and sectors protects your portfolio from lopsided risks while smoothing out returns. This is true regardless of what you invest in.

Stay the course. Don’t panic-sell underperformers if they’re sensible long-term choices. Their time will eventually come. Adding to recent underperformers can often boost long-term returns as you get to buy more while prices are low.

Final thoughts

It’s easy to be tempted by top-performing funds. The numbers look good, and the fear of missing out is real. But investing based on past performance can be a trap.

I’m not saying what has performed well recently can’t continue. The whole point is that we can't be sure it will, so it makes sense to invest accordingly. We can never know the future, so the best we can do is learn from history, have reasonable expectations, and put probabilities on our side.

Take a step back. Think long term. And build a strategy that isn’t so reliant on predicting the future. Remember, investing isn’t about getting ahead in the short-term, it’s about building sustainable and long-lasting wealth over decades.

Until next time, happy long-term investing!

Dave’s best-selling book Strong Money Australia is available on Amazon. Listen to the audiobook on Spotify or Audible.