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:

Fund

YTD
Return

United States 12 Month Oil (AMEX:USL)

37.3%

PowerShares DB Energy (DBE)

35.1%

PowerShares DB Oil (DBO)

35.1%

ProShares UltraShort Financials (SKF)

21.2%

United States Natural Gas Fund (AMEX:UNG)

17.5%

Source: Google Finance. Returns through July 31.

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.

Which mutual funds are most likely to make you serious money? Find out with a free 30-day trial to the Fool'sChampion Funds newsletter.

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.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 704043, ~/Articles/ArticleHandler.aspx, 12/19/2014 8:57:44 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 10 hours ago Sponsored by:
DOW 17,778.15 421.28 0.00%
S&P 500 2,061.23 48.34 0.00%
NASD 4,748.40 0.00 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/18/2014 4:01 PM
CHK $19.14 Up +0.46 +0.00%
Chesapeake Energy CAPS Rating: ****
FMCC $2.26 Up +0.08 +0.00%
Freddie Mac CAPS Rating: **
UNG $18.74 Down -0.06 +0.00%
United States Natu… CAPS Rating: **
USL $26.75 Down -0.69 +0.00%
United States 12 M… CAPS Rating: **
WAMUQ.DL $0.00 Down +0.00 +0.00%
Washington Mutual,… CAPS Rating: No stars
XOM $91.16 Up +2.14 +0.00%
ExxonMobil Corp CAPS Rating: ****

Advertisement