5 Evil Mutual Funds You Should Never Own

by Neal Frankle, CFP ®

If you want to know how to invest well and achieve your long-term goals please understand that there are certain funds you should never ever even think about owning. That’s not to say you can’t make money at one time or another owning these funds. You can. 

But unless you can predict the future, you’ll take on way more risk than you have to. And you’ll have to deal with a ton more volatility. And at the end of the day, your overall portfolio performance will likely stink. To me, that doesn’t sound like a good trade off. Just what are these dumb funds and why are they such a bad deal?

1. Country Funds

Unless you are a genius scholar and know something that nobody else knows, stay away from funds or ETFs that only buy stocks within one country. “Hot” country funds are notorious for being uber-hyped and that leads to speculation. Sooner or later the bubble bursts and investors are the ones left with gum on their faces. Not pretty.

Remember when China and India were “can’t miss investments”? Conventional wisdom said you couldn’t go wrong owning a China or India fund five or six years ago. While the fundamentals for both places did (and still do) look good, speculators ran the country fund prices up too fast and then laid those opportunities to waste.

Over the last 5 years India Fund IFN lost 40% while the S&P gained 40%. China Fund FXI is up about 3% over the last 5 years but it’s still done terribly compared to the S&P. And both funds (like every country fund) exposed investors to extreme capricious price movements. When it comes to country funds, just so “No Merci”.

2. Commodities

Commodity funds include those funds that buy single commodities (like gold, oil, or coffee) a compilation of commodities in a sector like energy or even a broader group of commodities like a natural resource fund. Either way, these are investments better left to the experts.

Let’s look at one example. Gold (as represented by ETF GLD) did far better than the overall market for years – until it didn’t. Consider the chart below.how to invest 
As you can see, over the last 5 years Gold has only done slightly better than the S&P but with far wilder swings in value. Of course this is no predictor of what lays ahead for Gold prices – or anything else. But gold, like all commodities are always the target of choice for speculators and speculation is the enemy of long-term investing. Unless you are willing to take on a lot of risk or have special expertise, forget about commodities in your portfolio.

3. Emerging Markets

While country funds only buy stocks in one country or geographic region, an emerging market fund holds stocks in countries with emerging economies like Argentina, Hungary, Peru, China, Russia, India, Brazil and Turkey. The story the fund managers try to sell is that these economies are growing quickly and these funds offer you an opportunity to take advantage of that. This might be true in some cases at some times. But these funds have big risks.

These are very narrowly based and undiversified funds. The economies of these countries are subject to far greater ups and downs than more mature economies. These countries don’t have the same accounting or oversight standards and the governments of these places are often unstable.

4. Short Funds

Short funds sell the market short. That means they sell stocks they don’t own with the hope of buying them back later on when prices are lower and making a profit. If this sounds like speculation to you, you are right.

No matter how strongly you are convinced that the market is about ready to crater, I suggest that you reconsider before buying short funds. If you look at the facts, you’ll see that the market’s natural tendency is to go up.

But short funds only make money when the market falls. So to make money with short funds you have to be expert in timing the market. That’s a skill few people have. In 2009 not too many people were optimistic about the stock market. But if you bet against it over the last 5 years, you’d have lost 40% of your capital. Ouch.

5. Leveraged Funds

Leveraged funds try to produce 2 or 3 times the return of a particular index. So if the market goes up by 2% in a week, a double leveraged fund might deliver a sweet 4% climb. Of course the knife cuts both ways. A 3% drop in the overall market could cut your double leveraged fund by 6% over the same period. That hurts.

Leveraged funds borrow money to invest and that’s how they amplify the market returns – good and bad. Does that sound risky to you? It should.

If you do a little research on the worst mutual funds in any particular year, you’re going to see that list populated mostly by funds that fall into one of these 5 groups. People fall into the trap of buying these types of funds (and losing a whole lot of money) because they are impatient and want to make a quick buck. This is really counterproductive to long-term wealth building and I strongly advise you against it.

To be frank, I have seen a couple of asset managers use some of the above in an asset allocation model and it’s worked really well. But those managers have special expertise and rebalancing tools that make it work. And these cases are the exceptions that prove the rule.

If you want to achieve your long-term goals, use long-term investments and stay away from these speculative choices. That’s my take on it anyway.

Do you buy funds in any of these 5 groups? How has it worked for you?

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