Learn From the Losers of the Past Decade

What if I told you that for every 1% the stock market went down, you could make 2%? Sound crazy? Well, most of the past decade's worst-performing mutual funds made that exact promise. Perhaps that strategy worked while the S&P 500 lost half its value from late 2007 to early 2009, but unless you're a day trader, it was -- and still is -- a dangerous investment strategy.

I don't recommend looking through a rearview mirror for investing advice, but I think it's valuable to learn lessons from past mistakes. So I wanted to take a look at the worst-performing mutual funds of the past decade and ask: Can we learn anything from the losers?

New math
When I used Lipper's screening tool to find the 10 worst-performing mutual funds of the past decade, I found that every fund on the list was managed by one of three mutual fund companies: Raffery Asset Management (managed one of the 10 funds), ProFund Advisors (five of the 10), and Security Investors (four of the 10). Come on, guys. ProFund? Security? These investments are anything but.

The worst offender lost 98% over the past decade, making a $10,000 initial investment worth a meager $200. Maybe you feel disheartened by your own investment returns. But believe me, scanning the loser list will make you feel downright, kiss-your-most-recent-portfolio-statement grateful.

Worst offenders
All 10 of the worst offenders boasted ultra-speculative, short-term methodologies. The funds "seek leveraged returns relative to an index and only on a daily basis" -- an attractive strategy to investors who are dissatisfied with getting rich slow.

Four of the 10 worst-performing funds short the Nasdaq, including the ProFunds UltraShort NASDAQ-100 ProFund. Another two of the 10 worst-performers short the S&P 500, including ProFunds UltraBear ProFund and Guggenheim Inverse S&P500 2x Strategy Fund.

A $10,000 initial investment in ProFunds UltraShort NASDAQ-100 ProFund would be worth less than $1,000 today. To be fair, I wanted to see if bull leveraged funds -- those which are long the index instead of short -- performed any better. They did. For example, ProFund Ultra NASDAQ-100 ProFund would be worth $15,982. But even the bull leveraged funds underperformed PowerShares QQQ (NAS: QQQ) , a proxy for the index, which would equal $20,689 today.

The 10 loser funds are extremely aggressive and employ investment techniques that I don't fully understand, even after having been in this business for nearly a decade: futures, options, derivatives, forward contracts, swap agreements, inverse and imperfect correlation, leverage, market price variance, and short sale. Whew. My general rule of thumb: If you don't understand it, don't invest in it.

Most importantly, an investor doesn't need to employ any of these strategies to be successful. Leave these methods, and their awful returns, to the day traders.

A treacherous trifecta
In addition to speculation and a short-term focus, high fees, ridiculous portfolio turnover, and inexperienced management are common characteristics of the funds.

Among the worst performing funds, almost all had annual expense ratios much higher than their category averages, sometimes nearly double the average. That means more money went into the pockets of the fund managers, and less stayed in the shareholder's account.

Portfolio turnover figures for the worst performing funds also blew me away. One fund had a preposterous 1,297% turnover -- meaning the fund manager completely changed every single investment in the fund nearly 13 times over the course of one year! High portfolio turnover costs shareholders more money in fees and taxes.

For most of the losing funds, the lead fund manager had been at the helm for less than three years. Tenure in this business counts. Please don't hand your money over to inexperienced managers.

Mr. Market prevails
Foolish investors know that short-term swings in the markets are not only common, they should be expected. A stock market correction -- a decline of 10% or more -- occurs on average once a year. But Mr. Market has a way of turning the tables. In the words of Peter Lynch: "Stock prices often move in opposite directions from the fundamentals, but, long term, the direction and sustainability of profits will prevail."

So what's the real takeaway here? As investors we have choices and are privy to a wealth of sound information. Don't be (small-f) fooled by investments that use esoteric methods and seem sketchy. If something appears too good to be true, it probably is. Look for mutual funds with solid track records, low fees, and experienced managers.

If you prefer individual stocks to funds, then do yourself a favor and read about three stocks with stellar fundamentals. They are profiled in a free report crafted by my Foolish colleagues, 3 American Companies Set to Dominate the World.

At the time thisarticle was published Fool contributorNicole Seghettidoes not owns shares in any of the investments mentioned in this article. She is prone to migraines when scrutinizing mutual fund prospectuses. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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