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For small investors, mutual funds are the best financial product ever designed. With very little money, you can invest in funds that own shares of hundreds of different companies.

Unfortunately, many of the thousands of mutual funds available don't perform well. Most actively managed funds, with holdings chosen and maintained by financial professionals, lag the overall market, largely because of transaction costs and fund fees. That's why many fund investors stick with index funds, which simply seek to match the performance of a specific market index.

Finding the right funds
Nonetheless, we believe that the right actively managed funds can outperform the market over the long term. Superior mutual funds that meet three crucial tests:

  1. Diversification: Strong mutual funds provide broad, risk-controlled exposure to the market's sectors without watering down their managers' best ideas amid hundreds of picks.
  2. Performance: The average fund lags the S&P 500 over time, but the funds we recommend are far from average. To make the grade here, a fund must have a talented manager, a sound stock-picking methodology, and a track record of beating the S&P.
  3. Costs: We recommend no-load funds whose expense ratios stack up well relative to (a) the fund's performance over time, and (b) the overall mutual fund universe. Tax efficiency is a major consideration, and we dock funds that charge 12b-1 marketing fees and other unnecessary costs.

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