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In most bear markets, you can find somewhere to hide. But this time around, there's really no harbor from the financial storm.

No one knows that better than mutual fund investors. You may have thought that a diversified portfolio of mutual funds and ETFs covering a wide range of assets would protect you from declines -- or at least offset them somewhat. Yet because of the unprecedented confluence of factors that have driven down markets around the world, you may well see losses in nearly all of your funds.

Gimme shelter
Out of all the fund categories that Morningstar tracks, there are only two ways you could have invested to make money so far in 2008: either in government bonds or in bear-market funds. Everything else is down.

That includes stocks of all kinds, big and small, domestic and foreign. That's not a shock, given the turmoil in the markets around the world. But what is surprising is that more conservative investments are also down sharply. Conservative balanced funds are down more than 18%. Corporate bond funds have fallen between 4% and 22%, depending on maturity and credit quality. Even municipal bond funds are down, with some long-term muni fund categories falling double-digit percentages.

Falling short
And those are just averages. The bear market is challenging the ability of some extremely well-regarded fund managers to protect their shareholders' capital, and plenty of individual funds have done far worse than their respective categories. The famous Fidelity Magellan (FMAGX) has seen bets on stocks like AIG (NYSE: AIG  ) , Nokia (NYSE: NOK  ) , and Research In Motion (Nasdaq: RIMM  ) add up to nearly a 50% loss for the year. Dodge & Cox Stock (DODGX), meanwhile, has seen big losses in Sprint Nextel (NYSE: S  ) and Motorola (NYSE: MOT  ) contribute to a 44% drop so far in 2008.

When you own individual stocks, fear can cause you to make mistakes. But with mutual funds, you face two threats. One is that your fund managers may panic, making a huge mistake with your money. But even if your fund managers keep their cool, shareholder redemptions can also put your share value at risk. When mutual funds face a herd of selling shareholders -- as they have recently -- they have no choice but to sell off their holdings to raise the cash to pay them, no matter how low those holdings have fallen.

Tips for a healthy fund portfolio
So how can you protect yourself? Here are a few things to keep in mind about your fund portfolio:

  • Keep track of fund assets. Of course, as the stock market falls, the value of your fund's assets should drop as well. But if fund assets drop disproportionately, that's a sign of shareholders heading for the exits. That could force your managers to make bad decisions, jeopardizing your own shares.
  • Get diversified. U.S. stocks have actually performed better than many foreign markets, with emerging-market stocks like Petroleo Brasileiro (NYSE: PBR  ) and Vale (NYSE: RIO  ) taking especially large hits from the commodities bust. If you agree that going international is the right bet for long-term growth, you're getting a bargain now.
  • Spread out your fixed income. If you've never broadened your investments into corporate or municipal bonds, now's a great time to take a look. Sure, there's plenty of risk even with these conservative investments, as credit risks for both companies and municipalities are above normal levels. But higher yields compensate you well for that added risk.
  • Try out closed-end funds. In times of distress, closed-end funds have an advantage over their traditional counterparts: They don't have to worry about redemptions. Because sales happen in the open market, shares can trade at big discounts to a fund's intrinsic value -- and they are, especially in areas like junk bonds and other leveraged debt funds.
  • Other warning signs. Watch out for changes in fund managers. Even during ordinary times, a new manager can be a reason to sell -- but right now, you simply can't afford to have inexperienced managers at the helm.

Finally, just as we've been telling investors in individual stocks, don't panic. If you have a good investing plan, stick with it -- even through tough markets. In the long run, you should reap the rewards of your discipline.

For more tracking your investments through the bear market, read about:

To get specific recommendations of mutual funds that make the grade in protecting your money, take a look at the most recent issue of our Motley Fool Champion Funds newsletter. You can see our latest thoughts on how the panic will affect your investments free with a 30-day trial.

Fool contributor Dan Caplinger has seen his mutual funds take a beating. Petroleo Brasileiro is a Motley Fool Income Investor selection. Sprint Nextel and Nokia are Motley Fool Inside Value recommendations. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is a helping hand.

Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 23, 2008, at 10:21 PM, 181736065 wrote:

    The real shame of this is that the great majority of the decline (between 35% - 40%) of the decline has occurred in only in the last THREE MONTHS!

    But, all these funds, and even the funds recommended in Ready Made Millionaire are down by about HALF THIS YEAR?!?!?!?!

    Well, I guess we were on the brink of financial Armageddon... otherwise this never would have happened. Besides, even gold is down. Please, fellow fools.. tell me how this has happened and why nothing... nothing.... nothing is working!

    The real question is.. do we have further down to go? And when, and how, do we recover all our lost money that we saved over the last decade.

  • Report this Comment On October 24, 2008, at 2:25 PM, lucas1985 wrote:

    - Gold is down because it's also a victim of the commodities bubble. Still, I think that the medium-term trend for gold is bullish.

    - Shorting stocks is working for sure.

    - Yes, we will go further down (the Dow will shred another 500 to 1000 pts IMHO). The market is still a little bit overvalued with a longer-than-average recession in the horizon. The market will react to every bit of news or rumors (earnings reports, key indexes, unemployement and more)

    - Your money will be recovered in the next bull market. Give your holdings at least 5 years.

    Be sure to be exposed to:

    * International markets; they have fallen much more than the USA and some are developing economies (this mean that they will likely experience higher growth rates) But I'm bearish on Westerm Europe and I'm not sure about Japan.

    * Basic materials. Obama (the next USA president for sure) may want to do some big investments on public infrastructure. Also, the emerging world is still constructing homes, factories and public buildings.

    * Dividend payers. Enough said.

    * Small-cap value players. The most inefficient portion of the market usually is the first to rebound and the one which rebounds higher.

    * 21th century trends. Efficiency (transport, energy), green business, Internet and cloud computing, new materials, etc. But be very careful here.

    Be wary of:

    * Financials and everything heavily exposed to housing, MBS and everything else. Expect more bad news here.

    * Business reliant on debt (cheap credit is over for good) to carry their daily activities. Prime example: GM.

    * Consumer discretionary and luxury spendings.

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