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 May, these funds rise to the top:

Source: Yahoo! Finance. Returns through May 30.

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 oldest one is United States Oil, which has been around for just over two years. The rest have track records of 12 to 18 months -- 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 two years 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 two years, you're not getting a manager who's been on it long enough to have significant experience in both bull and bear environments.

All of these five funds 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, 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 important, most investors have no strategic need for these funds. The UltraShort Health Care ProShares fund is a leveraged fund offering 200% of the inverse of the return of the Dow Jones U.S. Health Care Index. I can't think of many investors for whom this makes sense, unless you're simply betting on these narrow market segments to make a quick profit. That's more like gambling than investing.

And 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.

Moreover, none of these funds invest in any underlying oil, natural gas, or health-care companies. They invest solely in derivatives -- futures contracts or swaps. Owning stocks in these sectors does not really diversify 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 mutual funds instead of ETFs. 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 hold very 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. The Fool's disclosure policy never forgets.