When investing in solar, be sure to buy companies that actually make a product. Image source: First Solar.

What's the easiest way to lose money in solar energy?

The answer might be surprising. It's by buying solar exchange-traded funds. A solar ETF will give you a diverse set of solar stocks, but the one thing you're guaranteed to own is every major solar fraud or overleveraged company headed for disaster. In the last week alone, two such companies have sunk solar ETFs.

Do you know what's in that ETF?
One of the largest solar ETFs is the Guggenheim Solar ETF (TAN 1.95%), which has $438.5 million in assets. This is the go-to ETF in the solar industry, but in recent years it has wildly underperformed some of the better-known solar companies in the U.S. That might seem strange since this is supposed to be a way to buy a diverse number of solar companies and get some component of all of their returns.  

TAN Chart

TAN data by YCharts.

The Guggenheim Solar ETF has done so poorly because it owns the best and the worst companies in solar. You're all but guaranteed to own the next high-profile bankruptcy in the business by owning this ETF. In fact, it has historically been highly invested in some of the worst stocks in the industry, including Yingli Green Energy (NYSE: YGE), Suntech Power, and LDK Solar.

TAN Chart

TAN data by YCharts.

This week alone, the market highlighted why this is such a bad way to invest in the solar industry.

The typical ETF holding
Coming into the week, Guggenheim Solar ETF's largest holding was Hanergy Thin Film Power Group. This is by far the most valuable solar company in the world and it's also likely engaging in fradulent activities.  

Hanergy has collected assets from a number of defunct solar companies in the U.S. that have very little chance of ever making a profitable solar product. Most of its sales are to its parent company, a huge red flag for any investor. This week, its chairman skipped the company's annual meeting, where questions about Hanergy's operations were sure to be front and center. The stock tumbled, but the company still has a market cap near $20 billion, more than SunEdison (SUNEQ), SunPower (SPWR), and First Solar (FSLR 3.15%) combined.

The other bad news this week came from Yingli Green Energy, once the largest solar panel manufacturer in the world and now another company just trying to survive. Yingli used billion in loans from Chinese state-run banks to build manufacturing capacity over the last few years; now it's uncertain if those banks will extend those loans. A line in the company's annual filing with the SEC questioned its ability to continue as a "going concern," which is the first sign a company could be in major financial trouble.

A better way to invest in solar
It might be scary to bet on solar stocks, but I think owning a solar ETF is even riskier than buying a basket of the best companies. With the ETF, you'll more than likely get terrible returns because you'll own every company that goes bankrupt, and many more will in the next few years.

A better idea would be to buy strong U.S.-based companies that offer financials you can trust. I would start with SunPower, SunEdison, First Solar, and SolarCity (SCTY.DL) because they're leaders in their businesses and they should maintain that market position as the industry grows. I'd be much more comfortable owning those stocks than owning an ETF whose biggest position is highly questionable at best. No investor should be subject to that risk.