Critical Reasoning

Investment Advisor: It is well-known that investing in mutual funds reduces portfolio risk through diversification. It is also true that past investment performance is often related to future investment prospects. Therefore, to help my clients earn high returns with low risk, I select a group of mutual funds that meet the client’s objectives and then invest the client’s assets in the fund that has delivered the highest returns in this group over the past 2 years.

Which of the following statements, if true, would demonstrate a serious flaw in the approach of the Investment Advisor?

A) Managers of many mutual funds that have delivered the highest returns over the past several years have already used up their best investment ideas and are unlikely to sustain this level of performance in the future.

B) Mutual funds span a wide spectrum of investment styles and performance objectives and no single fund is suitable for every investor.

C) Many individual investors choose to manage their own portfolios rather than consult an investment advisor.

D) The funds that have had the strongest past performance tend to continue to outperform other funds with similar objectives for many years in the future.

E) The number of clients served by the investment advisor has declined by nearly 50% over the past 5 years.