Don't Buy These Top-Performing Funds

Investors have notoriously short attention spans. They focus too much on recent market events, quickly forgetting the hard-learned lessons of years past. Considering only the past six or 12 months of performance is a sure way to make costly investment mistakes. Don't believe me? Let's take a close look at some of the best-performing funds so far this year.

Topping the charts
To date, the 2008 market has been truly challenging for most equity funds. But if we examine year-to-date returns through the end of July, these funds rise to the top:

Impressed? Thinking about buying in? If you are, imagine me slapping your hand with a ruler. Focusing on short-term performance is a definite no-no. Despite these strong YTD returns, Fools should not want to own any of these funds.

Behind the numbers
All of these funds are relatively new -- the three oldest ones (the ProShares fund and the two PowerShares funds) have only been around since January or February 2007. The other two were started later in 2007.  This means that they all lack a long-term track record we can judge them by. This alone should make investors wary.

Investors should always look for funds with track records that span both positive and negative market environments. A paltry year and a half of performance means that none of these funds can show experience in handling extended up or down markets.

Fund investors should also seek long-tenured managers or management teams. And because none of these funds have been around longer than a year and a half, you're not getting a manager who's been on it long enough to have significant experience in both bull and bear environments.

All five tickers are exchange-traded funds (ETFs), which track the performance of a certain index, or the price of a certain commodity. This reduces the importance of having an experienced manager somewhat, but investors should still demand to see a lengthy track record of investing success before they sign on to any fund, whether it's actively or passively managed.

Who needs them?
Most importantly, the majority of investors have no strategic need for these funds. The ProShares UltraShort Financials fund is a leveraged fund offering 200% of the inverse of the return of the Dow Jones U.S. Financials Index. This only makes sense for a narrow slice of the investing population, because the ETF allows you to try to bet against one segment of the market to make a quick profit. That seems more like gambling than investing. And while the fund has benefited in recent months from the rapid price declines in stocks like Freddie Mac (NYSE:FRE) and Washington Mutual (NYSE:WM), short funds like these only make money when the market is in decline. They are not appropriate long-term investment vehicles.

Similarly, how many investors have good reasons for wanting exposure to the oil or natural gas industries? If you plan to invest in oil futures to hedge against existing holdings or business strategies, owning one of these ETFs might make sense. But most investors are more likely to buy after seeing this sector's recent red-hot returns. The name of that game is performance-chasing, and it's a game investors can ill afford to play.

Moreover, none of the four commodity funds invest in any actual underlying oil or natural gas companies like ExxonMobil (NYSE:XOM) or Chesapeake Energy (NYSE:CHK). They invest solely in derivatives -- futures contracts or swaps. So, in effect, you're not really diversifying your portfolio; you're merely making a bet on the short-term direction of commodity prices.

Narrowly focused funds like these don't make sense for most investors. Many diversified mutual funds already have exposure to each of these segments, so you can get your sector-specific dosage from less risky, broad-based offerings. These types of funds could seriously overweight your portfolio in certain sectors, which is a recipe for disaster if those areas took a sudden dive.

Focus on the long term
Remember that short-term returns are exactly that: short-term. The five funds that currently top the year's performance charts invest in somewhat volatile asset classes, and they're just as likely to end up at the bottom of the list in the next six months.

It may be tempting to try to catch some of the hot performance these funds and sectors have experienced recently, but wise Fools know that's a losing battle. Focus on your portfolio's long-term goals, and block out all the short-term noise. Trends will come and go, but long-term strategic investing is forever.

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This article was first published June 25, 2007. It has been updated.

Amanda Kish heads up the Motley Fool Champion Funds newsletter service. At the time of publication, she did not own any companies mentioned herein. Chesapeake Energy is an Inside Value selection. The Fool's disclosure policy never forgets.