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A Look at the Best and Worst Funds of 2016

And what we can learn from them

 hare racing a turtle, 2016 Best/Worst Funds

Alamy

Here's what smart investors can learn from the best and worst funds of 2016.

According to a recent article by 24/7 Wall St. about the best and worst fund investments of 2016, there were some huge winners and huge losers last year. Winners included the US Global Investors World Precious Minerals Fund (UNWPX), up 75 percent, and the Direxion Daily Semiconductor Bull 3X ETF (SOXL), up over 123 percent. Losers included the ProFunds UltraShort Latin America (UFPSX) fund, down nearly 63 percent, and the Direxion Daily Junior Gold Miners Index Bear 3x ETF (JDST), down over 97 percent.

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While I wish I had owned the winners and am happy I didn't own the losers, I'm going to take this opportunity to explain what they had in common, as well as leave you with three lessons for managing your investment portfolio.

What they have in common

Without going into detail, one of the winners and one of the losers invest exclusively in the precious metals and mining sectors. The winner owned stock in mining companies, while the loser borrowed money to bet stocks in that same sector would decline. The second winner borrowed money to bet on the semiconductor industry stocks, while the other loser borrowed money to bet against Latin American stocks.

So these four funds had four things in common. First, they were picking very specific parts of the market to invest in. Mining, semiconductors and Latin American stocks make up a tiny part of the global stock market. Second, three of the four are known as leveraged funds, meaning they borrow money to make even larger bets. Third, the winners were losers not too long ago, and the losers were previously winners. Finally, all were expensive funds to own, with annual expense ratios from 0.97 percent to 2.78 percent annually.

Three lessons learned

Like I said, I'd rather have had the winners than settle for the 12.7 percent return of my Vanguard Total Stock Market Index Fund (VTSAX), but I learned long ago that:

  • Winners of the past do not make winners of the future. In fact, according to a study by investment tracker Mark Hulbert and S&P Dow Jones Indices, top performing funds tend to underperform going forward.
  • Volatility is bad. Investing in a specific part of the market, especially borrowing money to buy even more of it, creates both greater risk and the potential for greater reward. But risk and reward aren't created equal. For example, had you made 123 percent on the Direxion Daily Semiconductor fund, only a 55 percent loss would wipe that gain out, which isn't difficult for a leveraged fund. On the other hand, if you had owned the Direxion Daily Junior Gold Miners Bear, which lost 97.64 percent, you'd need about a 4,237 percent return to recover, which is nearly impossible.
  • Fees take from returns. Though it's true that two expensive funds performed well in 2016, it's also true that fees weigh down investor returns in the long run. In fact, three of the four had losses over the past five years while my boring total stock fund nearly doubled in value.

My advice is to not try to hit the home runs. No matter how brilliant the managers of the star funds in 2016 may sound on TV, the odds are that those stars will flame out in glory and leave investors with losses. Sure, owning the entire market for the long-run through an index fund is boring but, in this case, boring is better.

Allan Roth is the founder of Wealth Logic, an hourly based financial planning firm in Colorado Springs, Colo. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.

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