Riskiest funds fare best over time — but can you keep clients in them?

If you could go back in time 30 years, you’d probably have some words of advice for your younger self. For example, no one is really impressed by your ability to throw a Frisbee. At some point, you run out of things to do with a crate of bananas. And there are consequences to crawling into the lemur cage at the zoo at midnight.

One you’ve put aside those pressing matters, you might also want to talk to your younger self about investing, albeit with the benefit of hindsight. Assuming there is some sort of cosmic time-travel rule against telling people to sell their house in 2006 or buy Google’s IPO, you can find some lessons for your younger self — and your children as well — by looking at returns over the past three decades.

Thirty years seems like a good time span, since it’s about the length of time people have to save over a working life, assuming that they waste a few years because of youthful folly or poverty. (And, yes, starting to save earlier is always better.)

“My first investment was 29.5 years ago, in early 1989,” said Morningstar columnist John Rekenthaler.

In very general terms, the first thing you learn is that stocks fare best over the long term. “Equity beat fixed income, fixed income beat cash,” Mr. Rekethaler said. “Although fixed income did pretty well.”

The Standard & Poor’s 500 stock index gained an average 10.70% a year over the past 30 years, while long-term government bonds gained 7.33% a year and money funds clocked in at 3.04% a year. Foreign stocks in general have done little to prove the advantages of international diversification: The MSCI Europe, Australasia and Far East index has gained just 5.97% a year since 1988.

And if you happen to have an Ibbotson wall poster of long-term asset class returns, you’ll feel vindicated. Small-company stock funds (up 10.95%) beat mid-cap stock funds (up 10.93%), and mid-cap stock funds beat large-cap stock funds (up 9.15%).

The very best performers were also among the riskiest. Health-care funds were the top-performing category, cruising at 13.98% a year for three decades. Technology funds notched an 11.75% annual gain, and financial funds scored an 11.44% gain.

Consumer defensive funds gained 12.05% a year over the same period. These invest in high-quality stocks of companies that produce things we use every day —often the favorites of superstar investor Warren Buffett.

But there were precious few consumer defensive funds in 1988, which points to one of the limitations of the data. “I don’t know how many there were back then, but it would be a rounding error if I said none,” Mr. Rekenthaler said.

With that exception, nearly all of the top-performing funds the past 30 years have been high-beta funds, which is a polite way of saying that they are prone to heart-stopping declines. Technology funds — those that survived — plunged during the 2000-2002 tech wreck. Financial stocks did the same during the financial crisis of 2007-2009. Very few investors have the intestinal fortitude to buy and hold those funds for three decades.

“There are lots of studies that show that buy-and-hold returns have been much better than what actual investors have gotten,” said Ray Ferrara, CEO of Provise Management Group. “There are those who will ride through it, but they are generally those who haven’t been paying attention.”

And that’s part of the problem with looking at a 30-year time span, said Steve Janachowski, CEO of Brouwer & Janachowski. “When you take a 30-year time period, it tends to smooth out the cycles,” Mr. Janachowski said. “But most investors try to time the cycles, and that’s really hard. They wait until the cycle gets hot, then they jump in — that’s good for a while, but then they get smashed.”

In fact, one of the broad lessons from the past 30 years is that market timing has been an abject failure. “After the 1987 crash, a lot of people were knocking buy-and-hold,” Mr. Rekenthaler said. “But when we looked at the records, people who try to time the market tend not to do well.”

The 30-year record also vindicates the notion that it’s good to buy low and sell high. Technology stocks were knocked hard in the 1987 stock market crash, and health-care funds fell 7.60% in 1987 — one basis point below small-company blend funds. Japan funds screamed ahead at a 20.99% annual rate over the 10 years ended in 1987, and precious metals fared even better, running at a 23.45% annual rate.

One of the best things an investor can do, sometimes, is to make a fund investment and forget about it for 30 years. “It’s amazing how many times I’ve run into someone who has looked into an old shoebox, found some statement from a mutual fund he had invested in and forgot all about it,” Mr. Janachowski said. “And I’ve looked it up and said, ‘Look how much it’s gone up over 25, 30 years. It kept compounding without him messing with it.”

Short of having forgetful clients, however, the best thing an investor can do over the long term is have a very thick skin — or an adviser who can keep his asset allocation to a level he can stand. “Boring as it is, a well-allocated portfolio, rebalanced according to guidelines, should perform well over time,” Mr. Ferrara said. “Those who chase the hot fund wind up losing.”