Reversion to the Mean
Styles, sectors, and funds that have recently outperformed tend to see that advantage fade back toward the market's average over time.
A closely related pattern to the previous two chapters: investment styles, sectors, and individual funds that have outperformed for an extended stretch tend, over time, to see their advantage fade back toward the broader market's average — a pattern commonly called reversion to the mean.
This shows up in more than just individual fund manager performance — a sector or investing style that has recently outperformed tends to attract more capital and attention chasing that same recent success, which can itself set up the conditions for underperformance going forward, as the previously-underappreciated opposite style or sector becomes comparatively cheap.
Bogle's point in raising this isn't to argue for actively rotating between styles or sectors trying to time the reversion, which reintroduces the same forecasting difficulty covered elsewhere in this course — it's to argue that chasing whatever has recently outperformed is a systematically unreliable strategy, and a broad, all-market index fund sidesteps the whole problem by simply owning every style and sector at once, in proportion to the market itself.
| Chasing recent outperformance | Owning the total market | |
|---|---|---|
| What decides the mix | Whatever style or sector has recently done best | The market's own actual composition, unchanged by recent performance |
| Risk from reversion to the mean | High — recent winners are disproportionately likely to lag going forward | Low — you already own the eventual future winners and laggards alike, in proportion |
A particular investing style outperforms the broader market substantially for several years, attracting a large wave of new money specifically chasing that recent success.
In the years that follow, that same style underperforms the broader market, partly because the earlier outperformance had already pushed its valuations up relative to everything else, and partly because the previously out-of-favor alternative style, now comparatively cheap, has more room left to recover. An investor who chased the winning style right as the wave of new money arrived would have bought in near the top of that particular cycle.
A total-market index fund doesn't need to correctly predict which style or sector will outperform next, because it already owns all of them simultaneously, in the market's own actual weighting — reversion to the mean between styles or sectors, whichever direction it runs, is automatically captured rather than needing to be predicted or timed.
- Outperforming styles, sectors, and funds tend to see their advantage fade back toward the market average over time.
- Chasing recent outperformance risks buying in exactly as that advantage is set to fade, precisely because the outperformance is what attracted the chasing money.
- A total-market index fund owns every style and sector simultaneously, automatically capturing reversion to the mean rather than needing to predict its direction or timing.
- This is an argument against style/sector rotation generally, not a case for finding a cleverer way to time it.