Investors have notoriously short attention spans. They focus too closely on recent market events and quickly forget the hard-learned lessons of years past. Considering only the past six or 12 months of performance is a surefire way to make costly investment mistakes.
Don't believe it? Take a look back at any top-performing sector historically and see how long it's able to sustain strong returns. Internet funds in 1999 looked great, but by 2002, they were decimated. The same thing was true of emerging-markets funds in 2007 and commodities funds in 2008. They each had impressive returns that would tempt you to buy in at the peaks -- and then you'd get slapped when the bottom fell out of the market.
Focusing on short-term performance is a definite no-no. It's critical to look at fund performance in both good and bad market environments. Despite the impressive returns, short-term top performers should make Fools wary.
Behind the numbers
Here's the thing: Typically, when a sector becomes popular, new funds flock to where investor interest is. That means many funds are relatively new, thus lacking any kind of long-term track record to judge them by. This alone should make investors wary. Investors should always look for funds with track records spanning both positive and negative market environments. Without a good track record, you have no idea how a fund will perform when the market sours. Similarly, without a management team that has enough experience to deal with both up and down markets, you never know whether your fund manager will panic at exactly the wrong time.
Most importantly, though, the majority of investors have no strategic need for most funds that show up at the top of performance lists. Typically, the highest performers are niche funds that focus on a particularly successful market segment. For most investors, the only reason for such funds is to make a bet specifically to make a quick profit. That seems more like gambling than investing.
Keep your eye on the long term
Remember that short-term returns are exactly that: short-term. Whatever funds currently top the year's performance charts are extremely volatile and are just as likely to end up at the bottom of the list in the next six months. While it may be tempting to try to catch some of the hot performance these funds and sectors have experienced in recent months, Fools know that's a losing battle.
Since long-term returns are most predictive of future performance, you should look for funds that have been around for a significant amount of time and have a good track record to draw on. That means avoiding newer, trendier products that are chasing hot money. Many fund companies and asset managers throw a lot of products at the wall to see what sticks, but you should avoid them until they've proved themselves.
In other words, focus on your portfolio's long-term goals, and try to block out all of the short-term noise. Trends will come and go, but long-term strategic investing is forever.
Next, we turn to one of the most important factors in a fund's success.