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Treasury funds show folly of chasing performance

OK, performance chasers, the data are in. One investment class provided returns last year that were leaps and bounds ahead of all others. The average fund in this class earned nearly 30 percent in 2011, running circles around the 2 percent return provided by the S&P 500.

So your choices are to sit there like some kind of fool waiting for the stock market to rebound, or go out and make sure you get your share of what's hot in the markets.

So what is this asset class that produced such remarkable returns in 2011?

Long-term Treasury funds.

Yes, the funds that owned the very securities that Bill Gross, Jeremy Siegel and just about every investing expert on earth didn't want anything to do with a year ago ended up producing another year of stellar returns.

Of course, that performance was attributable to the fact that interest rates, which began the year near historic lows, defied belief and continued to decline. The fact that in order to replicate such returns, interest rates would have to decline even further in 2012, explains why this is one of the rare times in history when investors aren't clamoring to load up on a recent top performing asset class.

But if no one in their right mind would load up on long-term Treasury funds in the hopes of another year of 30 percent returns, an investor who did so is only separated by a few degrees from one who piles into small-cap stocks or gold or emerging markets on the basis of the short-term performance of those asset classes.

And yet that's what investors do. Time and time again, they pile into the funds or asset classes with the best short-term performance, only to bail out when that performance inevitably reverses.

The impact that this behavior has on investor returns is stunning. In the 20 years ended 2010, the S&P 500 earned an average annual return of 9.1 percent, a rate that would grow an initial investment of $10,000 by $47,100. In that same period, investment research firm Dalbar estimates that, thanks to performance chasing and the like, the average equity fund investor earned a return of 3.8 percent, which would grow that $10,000 investment by $11,100 -- not even a quarter of the total profit that was available had they been able to keep their emotions in check.

The next time you find yourself compelled to buy that hot fund or dip a toe into a top-performing asset class, ask yourself if you would use the same logic to dive into long-term bonds when interest rates were scraping zero. Both choices are likely to prove unwise.