When Funds Are Smarter Than Stocks

The idea that a savvy individual investor with the right approach can beat the Wise Guys of Wall Street at their own game is the very cornerstone of Foolishness. But as Fool fund guru Amanda Kish often says, there's no reason you can't apply that approach to the world of mutual funds as well.

Let's face it -- for many (heck, most) of us, the money we invest through our workplace 401(k) or 403(b) plans represents the biggest chunk of our nest eggs. In the vast majority of those plans, your investment options consist of (a) mutual funds and (b) more mutual funds, with maybe employer stock or a few other odds and ends thrown in for good measure.

Clearly, every Fool will have to come to terms with mutual funds sooner or later. And that's a good thing: Despite their well-known drawbacks -- fees, institutional pressures that lead to short investment horizons, an industrywide history of market-lagging performance -- an actively managed mutual fund is often just a better solution than picking stocks yourself. A few funds would make great additions to any portfolio. More on how to find those in a bit.

What are the situations in which a mutual fund is the best option? Four come to mind.

• You don't have the time or inclination to manage a stock portfolio. Long the biggest selling point of mutual funds, this remains a strong part of their appeal -- diversification and professional management that's quick and easy to buy. You can build a complete U.S. stock portfolio with just two or three funds. For instance, put a fund that specializes in value-priced big names such as 3M (NYSE: MMM  ) and Johnson & Johnson (NYSE: JNJ  ) together with a more aggressive growth fund that owns companies such as Apple (Nasdaq: AAPL  ) and Garmin (Nasdaq: GRMN  ) , and you've got yourself a complete, diversified stock portfolio that should perform well over the long haul, with minimal maintenance -- provided you pick good funds, of course.
  
  
• You want access to esoteric assets or markets. You may know what a junk bond is, but did you ever try to buy one? Do you understand the complexities of the scary end of the bond market well enough to make informed investments? Or would you rather hire someone who makes a living picking junk bonds to assemble and manage a junk bond portfolio for you?
  
  Foreign markets, too, can present challenges for the individual investor. For instance, if you wanted to add emerging-markets exposure in your portfolio, you could just buy stocks like Baidu (Nasdaq: BIDU  ) , Vale (NYSE: VALE  ) , and Shanda Interactive (Nasdaq: SNDA  ) -- and hope for the best. But you could also hire your own submanager for your portfolio -- someone who knew the territory far better than you ever would -- by buying into an emerging-markets fund. That would give you much more diversified exposure than if you tried putting together a few stocks on your own.
  
  
• You want no-brainer market-matching performance. Want to track the results of a market index -- any market index -- at low cost? Buy a low-cost index fund. Boom, all done.
  
  
• You want to beat the market, with less hassle. Yes, we Fools often go on at length about how most actively managed funds lose out to the market averages over time. But there are a few bright, shining exceptions -- funds with sound strategies and skilled managers that outperform year after year. As Amanda says, for those who want the market-crushing benefits of good stock picking without having to do all the work, those funds can help you survive down markets.

And speaking of Amanda -- and not doing all the work yourself -- if you want to find those bright, shining exceptions quickly and easily, the Fool's Champion Funds newsletter service is the way to go. Amanda's the ringleader over there, and every month she offers up a well-researched recommendation, together with several pages of great educational content.

All of the back issues are available, all past picks are tracked and updated, and there's a great members-only message board for your questions and comments. The price is a pittance compared with the performance gains your portfolio will receive, and we'll spot you a 30-day all-access guest pass so that you can check it out thoroughly before spending any money. There's no obligation to subscribe.

More on funds and Foolishness:

• Don't Buy These Top-Performing Investments
• Why the Market May Not Have Reached a Bottom Yet
• What Wealthy Investors Are Doing Now