When a 69% Return Spells Bad News

The iShares MSCI Emerging Market Index (NYSE:EEM), an exchange-traded fund (ETF), rose 69% in 2009. That's certainly terrific news for its investors. But it can also lead to trouble for folks who jump recklessly into new investments on the basis of a blockbuster return.

Trust me, Fools -- I speak from experience. Long ago, I was lured into the Fidelity Emerging Markets (FEMKX) fund by an 84% one-year return. Who wouldn't want to almost double their money in a single year? Even the more modest 69% is nothing to sneeze at, either. It can turn a $10,000 investment into $16,900 in a single year. If it keeps up that rate, that initial investment could become $1.9 million in just a decade!

Pop quiz!
Now step back and see whether you can spot the colossally stupid assumption above. Ding ding ding! That's right: It's ridiculous to think that any investment could sustain a 69% return year after year.

Yet we still do often find ourselves drawn to big returns. We routinely look over lists of the best funds of the past year and lick our chops. We forget that most of those amazing returns will be one-year wonders. We forget that a 70% rise can easily be followed by a 50% drop. We forget that luck is often a factor in outsized returns -- a fund may have had a lot of energy holdings, for example, in a year when energy companies soared.

That said...
Just because a sector like emerging markets racks up an amazing performance or two doesn't mean you shouldn't put any of your money into it.

Emerging economies can grow faster than ours, earning them a well-deserved spot in many investors' portfolios. Adding international holdings can help diversify our assets and protect us against fluctuations in the dollar, among other virtues. If you're looking for solid global investments, consider these contenders:

Data: Morningstar.

Don't let one year's high returns scare you away from a sector -- or lure you into a stock or fund on the assumption that the good times will last. Instead, look at a fund's record over the past five years, 10 years, or since its inception. You'll also want to check out its management team, to make sure the folks responsible for that performance are still at the helm, and its expense ratio, to see just how much of its gains the fund will actually let you keep. Perusing a fund's fundamentals may not be as quick as flashy as admiring a dazzling one-year gain, but it'll serve you a lot better in the long run.