Quick: What's the investment vehicle of choice for more than 90 million Americans?

If you said "mutual funds," give yourself a gold star and head to the front of the cubicle.

Here's another quick one: Are funds so popular because, to pick up on our headline, they're the best investment vehicles ever?

Peaceful, easy feeling
To my way of thinking the answer is yes -- or, more precisely, yes, they can be.

The kind of funds worth building your portfolio around make it a cinch to spread your bets across value-priced big boys such as ExxonMobil, Citigroup (NYSE:C), and Wal-Mart (NYSE:WMT) -- long-haul market-beaters with price-to-earnings (P/E) ratios that fall below that of the S&P 500 -- and racier fare such as Genentech (NYSE:DNA), eBay (NASDAQ:EBAY), and Yahoo! (NASDAQ:YHOO). That particular power trio sports five-year earnings-growth forecasts in excess of 18% over the next five years. Amazon.com (NASDAQ:AMZN) strikes a similarly juicy profile.

If you're looking for a no-brainer solution, funds make that a breeze, too -- and you won't have to pay up for the privilege, either. SPDRs (SPY) -- the S&P 500-tracking ETF -- sports an expense ratio of just 0.08%. Vanguard 500 (VFINX) -- a traditional mutual fund that also tracks the S&P -- costs just 0.18%.

Here's the upshot, then: Well-chosen funds make light work of building a carefully calibrated portfolio. They're the most convenient vehicles for investing in asset classes that may lie outside your "circle of competence," too, which is generally a good idea. Doing so can allow you to sleep peacefully at night, secure in the knowledge that folks who do understand, say, emerging markets and high-yield bonds, are busy building your nest egg.

Reality bites
That said, when it comes to investing, mere convenience doesn't cut it as a thesis. And while I'm a fund fan, I'm also a realist -- funds are also popular because they're ubiquitous. 401(k) plans, after all, are lousy with them -- with an emphasis on the "lousy." And that goes double for the industry's typical entrant, a fund that likely requires shareholders to pay for the privilege of underperformance.

How to separate the keepers from the duds in your plan's -- or your brokerage's -- lineup? Keep the following points in mind, and you'll go a long way toward doing just that:

  • With funds, you're really investing in the manager. Don't focus on past performance unless that track record belongs to the person who's currently calling the fund's shots.
  • Look for low price tags. Unlike any other product, with funds, the price you pay is a feature of the "product" itself. The more you pay, the worse your performance will be; and the less you pay, the more moola you'll have compounding, as opposed to fattening the fund company's coffers.
  • Last but not least: Favor funds with proven strategies and managers who "eat their own cooking" by investing their own moola alongside that of their shareholders. 

The Foolish bottom line
We've been using the above core criteria since Day 1 at the Fool's Champion Funds investing service. So far, so good; our recommendations are collectively beating the market by a double-digit margin.

I'm proud of our track record, but the process we use to separate the wheat from the chaff relies on plain old-fashioned common sense. You can put the same wisdom to work in your portfolio, too. If you'd like to see how we do it at Champion Funds, click here for a risk-free guest pass. You'll have access to our recommendations list, model portfolios, and a special report that provides step-by-step assistance for making the most of your 401(k) plan. There's no obligation to subscribe.

Join Champion Funds today, and the Fool's latest premium report -- The NEW Rule Makers: 5 Power Stocks You'll Never Want to Sell -- is yours free. You'll also have access to our latest special reports: The Challenge: ETFs vs. Mutual Funds and Add Kick to Your 401(k)! Just click here to snag the reports (which are yours to keep) along with a risk-free Champion Funds membership.

This article was originally published on June 20, 2007. It has been updated.

Shannon Zimmerman is the lead analyst for the Fool's Champion Funds newsletter service. He doesn't own any of the companies mentioned. Wal-Mart is a Motley Fool Inside Value recommendation. eBay, Yahoo!, and Amazon.com are Stock Advisor picks. The Fool has a strict disclosure policy.