While oil prices soared from roughly $43 per barrel in early January to more than $55 by midyear, the broad market hasn't performed nearly as impressively. In fact, with a few exceptions, neither stock nor bond funds have taken off. So what's an investor to do? Diversification is the key. "I mix it up," says Steve Noakes, a consultant who specializes in information security in Falls Church, Virginia. "I have funds holding small-, mid-, and large-cap stocks, along with international stocks." This approach puts Noakes in a position to gain if one area of the market gets hot, and it protects him against steep losses such as those suffered by tech-heavy investors from 2000 to 2002. For the last 15 years, Noakes has invested in Fidelity Destiny II, a fund that held 111 different stocks at last report. With this fund, investors commit to monthly contributions for at least 10 years. "Investors should have a little bit of everything," says Ivory Johnson, director of financial planning at The Scarborough Group in Annapolis, Maryland. "Every asset class has its day in the sun, and you can't predict which will shine in the next six months. By filling in all the categories, you can reduce the volatility of your portfolio." Johnson says real estate mutual funds are among his most desirable holdings. The following were key trends in mutual fund performance in the first half of the year: Domestic stock funds posted slight losses (performance was down less than 1%). Value funds topped growth funds. Mid value, small value, real estate investment trusts, corporate bonds, and emerging markets were all up more than 2%. After natural resources, stock funds were led by two other niche categories: Latin American funds (up 11.78%) and utilities funds (up more than 10%). ooOn the bright side, there were no enormous losers. The worst performers were precious metals funds and technology funds, both down more than 5%. World stock funds, too, posted modest losses in the first half. Emerging markets stock funds (up 4.92%) did well. Emerging markets bond funds did even better, up 5.28%. More traditional bond funds generally provided smaller returns to investors. Investors are hoping performances during the second half fare a bit better. "There are no obvious answers," says Cheryl Holland, president of Abacus Planning Group in Columbia, South Carolina. Suppose, instead of diversifying, you put all your money into large-cap growth funds. Such funds are expected to be long-term winners but they can suffer severe losses in any given year. "If you're down 30% one year," says Johnson, "you have to gain 43% just to get back to where you were. By spreading your investments, you reduce the risk of taking such a huge loss." Noakes' approach to investment is a mixed bag. For example, 2002 was the worst year in recent memory for domestic stock funds (down more than 22%), while bond and real estate funds registered gains. A diversified portfolio would have experienced losses much less than 22%. Investing regularly as Noakes has done with Fidelity Destiny II is known as dollar-cost averaging, which assures you're buying when stocks are low as well as when they're high. Such long-term perseverance pays off: Fidelity Destiny II, for example, has returned nearly 13% per year for the last 15 years. With such results, an initial $10,000 investment would have grown to more than $60,000. Make combination plans. Historically, investors seeking double-digit returns have found them in stock funds rather than bond funds. Nevertheless, a truly diversified portfolio will include some bond funds, which held up well while stocks plummeted from 2000 to 2002. For instance, Bernee and Hillary Dunson of Atlanta, both 40, hold a mix of investments that includes individual stocks and real estate. "I also have a retirement plan at my dental practice," says Bernee. "There, I invest in mutual funds, which my wife and I select." Hillary says the retirement plan's largest holding is Buffalo High-Yield Fund. This fund, which primarily invests in "high-yield" (low-rated, or junk) bonds, delivered positive annual returns throughout the recent bear market for stocks and shows an annual return of about 9% for the last five years. Portfolio diversification also affects how the Dunsons invest for their two young children, who are literally model youngsters. The children's photos are used to promote Bernee's dental practice. Not only does this provide a nice tax break (deductible payments for the dental practice and tax-free income to the children), it also gives the younger Dunsons money to invest. "The money has been invested in Roth IRAs," says Lee Baker of Apex Financial Services in Tucker, Georgia, who serves as the Dunsons' financial planner. In 2005, up to $4,000 worth of earned income can be contributed by each child. Investment earnings are not taxed and, after age 591/2, withdrawals will be tax-free. "The Roth IRA money is invested in mutual funds," says Baker. "The same is true for each child's 529 plan." Again, 529 plans offer tax-free investing, provided that the money is ultimately used for higher education. For the young Dunsons, Baker recommends Virginia's 529 plan, choosing mutual funds run by American Funds. "Their money is in Investment Company of America for domestic stocks, New Perspective for global stocks, and Bond Fund of America," Baker says. "This is a nice mix of funds from a company that has done a good job of keeping costs low and providing excellent returns. The Roth IRA money is invested in American Funds Growth Fund of America, which rounds out their portfolios." Hedge your bond bets. Investors seeking to include bond funds in a diversified portfolio need to be careful these days. "With a flat yield curve, you might be better off with short- and intermediate-term bond funds," says Johnson. "There are concerns that long-term interest rates will rise." That is, short-term bonds now yield nearly as much as long-term bonds. If you invest in long-term bond funds to get a little more yield, you'll risk losing principal, because long-term bonds lose value when interest rates rise. "I also like TIPS funds," says Johnson, referring to mutual funds that invest in Treasury inflation-protected securities. These bonds, obligations of the federal government, will pay higher yields if inflation rises, as many forecasters expect. Johnson's firm has a policy that prohibits mentioning specific funds, but TIPS funds are available from several mutual fund families, including Fidelity, Vanguard, and PIMCO. Mark Salzinger, who publishes the No-Load Fund Investor newsletter out of Brentwood, Tennessee, offers another way to reduce interest-rate risk in bond funds. "Fidelity's Floating Rate High Income Fund invests mainly in bank loans," he says. "If inflation increases and interest rates move up, the rates on those bank loans will go higher, so payments to investors will rise." Stay well stocked. Among stock funds, Baker suggests that a core holding might be T. Rowe Price Total Equity Market Index Fund, which tracks the Dow Jones Wilshire 5000 Composite Index and thus provides exposure to the broad market. "Cutting expenses will pay off over the long term," he says, "and index funds tend to be less expensive than funds where the managers try to pick stocks." If you prefer funds that try to beat the market rather than match a broad index, you should hold several funds that buy different types of stocks. Russ Kinnel, Morningstar's director of mutual fund research, expresses an interest in funds that hold large company growth stocks. "I'm not arguing that large-growth is a sure-fire hit for the next 12 months,& quot; says Kinnel, "but you ought to get a pretty good return over the next five to 10 years. The managers of large-growth funds have very small cash positions, which signals that they are finding a lot of attractive investments." Over the last five years, large-cap growth funds have lost 8.32% per year while small-cap value stocks have returned 14.86% a year, so it may be time for the tables to turn. Large-growth funds might get a boost from a familiar market sector: tech stocks. "If I had to pick one area for investing, it would be technology," says Johnson. "Corporations are holding as much cash now as they've had in the last 45 years, and a great deal of that cash probably will go to upgrade obsolete technology. Rather than invest in a specialized technology fund, I'd choose a diversified fund with a manager who has been successful enough in picking sectors to outperform the market for the past five or 10 years." Among Morningstar's favored large-cap growth funds, Fidelity Capital Appreciation and Vanguard Growth Equity have substantial exposure to information technology. Growth funds can be balanced by value funds such as Artisan Mid Cap Value and TCW Galileo Dividend Focused Fund, which are Salzinger's selections. "Another way to diversify your portfolio," he says, "might be to invest in a fund that holds the stocks of companies that produce commodities, such as T. Rowe Price New Era." Keep up with foreign affairs. Once you have determined your allocation of stock and bond funds, the third leg of the stool is international investing. "We don't want to have all of our eggs in the U.S. basket," says Holland. "We're concerned that the dollar may weaken." If the U.S. dollar loses ground, the stocks of foreign countries are likely to appreciate as their currencies move up in value. "We have steadily recommended international allocations," says Holland, "including international small-cap and emerging markets funds for most clients. Altogether, about 20% of equity allocations are in international funds." Holland's favorite foreign funds include Harbor International (a value fund) and Artisan International (which holds growth stocks); for smaller accounts that may have room for just one foreign fund, she cites Vanguard Total International Stock Index Fund, which combines European, Pacific, and emerging markets indexes. "For international investing," says Johnson, "China and India are poised for growth while the European Union seems to have problems. My preference is to invest in a world stock fund and let the manager pick the best companies. However, you might want to look and see if the manager has a history of investing in the high-growth areas of Asia." Kinnel suggests combining Vanguard International Growth, a large-cap fund that does not hedge currency risk, with Tweedy, Browne Global Value, a fund that invests in smaller companies and hedges in order to protect U.S. investors from a weak dollar. "This strategy can provide more diversification for your overseas holdings," he says. Thus, to diversify your mutual fund holdings you must go beyond buying a few funds holding the same blue-chip stocks; you need various types of assets, domestic and international. "Your mother and your grandmother probably told you not to put all your eggs in one basket," says Baker. "Well, they were absolutely right. You shouldn't try to catch the 'next big thing.' Instead, stick to a diversified portfolio." B.E.'s Top Mutual Fund Performers FUND NAME TICKER SYMBOL 1-YEAR RETURN 3-YEAR RETURN 5-YEAR RETURN MINIMUM INITIAL INVESTMENT PHONE LARGE GROWTH Old Westbury Mid Cap Equity OWMCX 4.83% 4.23% 5.30% $ 1,000 800-607-2200 Legg Mason Growth Trust Primary LMGTX -2.92 22.35 3.14 1,000 800-822-5544 Calvert Social Investment Equity A CSIEX 5.56 6.70 2.81 1,000 800-368-2748 Dreyfus Premier Alpha Growth T BSFAX 6.03 6.60 2.72 1,000 800-554-4611 Fidelity Contrafund FCNTX 11.94 11.53 2.58 2,500 800-343-3548 MID GROWTH Delaware American Services A DASAX 11.30 17.87 16.33 1,000 800-362-7500 Eagle Growth EGRWX 17.22 7.27 11.16 500 800-749-9933 Meridian Growth MERDX 2.65 11.03 11.14 1,000 800-446-6662 Columbia Acorn Select Z ACTWX 10.23 14.49 10.71 1,000 800-345-6611 Munder MidCap Select A MGOAX 17.00 17.19 8.95 2,500 800-468-6337 SMALL GROWTH Oberweis Micro-Cap OBMCX 2.27 23.13 12.59 1,000 800-323-6166 Schroder U.S. Opportunities Inv SCUIX 14.48 14.55 11.10 10,000 800-464-3108 John Hancock Small Cap A DSISX 10.92 9.79 9.33 1,000 800-225-5291 Dreyfus Premier Future Leaders R DFLRX 9.98 10.42 9.29 1,000 800-334-6899 Dreyfus Premier Future Leaders A DFLAX 9.54 10.01 8.91 1,000 800-334-6899 LARGE BLEND Mairs & Power Growth MPGFX 5.96 11.52 11.16 2,500 800-304-7404 Century Shares Trust CENSX 6.09 7.57 11.06 250,000 800-321-1928 AmSouth Select Equity A ASECX -2.13 7.19 8.98 1,000 800-451-8382 Thompson Plumb Growth THPGX -4.23 7.41 8.61 valign="middle">2,500 800-999-0887 Fidelity Select Food & Agriculture FDFAX 8.80 5.25 8.19 2,500 800-343-3548 MID BLEND CGM Focus CGMFX 27.97 17.17 30.20 2,500 800-345-4048 Fairholme FAIRX 25.37 17.65 18.67 2,500 866-202-2263 Kinetics Paradigm WWNPX 27.44 22.17 16.88 2,500 800-930-3828 RS Value RSVAX 29.24 28.43 16.72 5,000 800-766-3863 FPA Paramount FPRAX 8.88 14.80 15.18 1,500 800-982-4372 SMALL BLEND Bridgeway Ultra-Small Co. Mkt Fun BRSIX 6.12 25.45 21.21 2,000 800-661-3550 Texas Capital Value & Growth TCVGX 20.39 19.40 20.45 2,000 800-880-0324 Stratton Small-Cap Value STSCX 23.11 20.02 19.49 2,000 800-634-5726 Pacific Advisors Small Cap A PASMX 4.38 19.97 17.78 0 800-989-6693 Strategic Partners Small Cap Value PZVAX 19.59 18.83 17.49 1,000 800-225-1852 LARGE VALUE Yacktman Focused YAFFX 7.37 14.52 17.97 2,500 800-525-8258 Yacktman YACKX 6.89 15.16 17.80 2,500 800-525-8258 John Hancock Classic Value A PZFVX 10.43 14.13 17.32 1,000 800-225-5291 Clipper Focus PBHG PBFOX 4.60 6.34 13.73 2,500 800-433-0051 Oakmark Select I OAKLX 8.61 9.50 13.70 1,000 800-625-6275 MID VALUE Fidelity Select Constr. & Housing FSHOX 31.82 18.85 22.54 2,500 800-343-3548 Delafield DEFIX 9.48 14.09 18.76 5,000 800-221-3079 Phoenix Mid-Cap Value A FMIVX 15.39 14.21 17.82 500 800-243-1574 Marshall Mid-Cap Value Inv MRVEX 10.93 13.75 16.61 1,000 800-236-8560 Janus Mid Cap Value Investor JMCVX 12.26 14.53 16.38 2,500 800-525-3713 Pacific Capital Small Cap A PCSAX 14.65 18.17 21.01 1,000 800-258-9232 Berwyn BERWX 16.37 16.41 20.88 3,000 800-992-6757 SMALL VALUE Pacific Capital Small Cap B PCSBX 13.78 17.29 20.08 1,000 800-258-9232 JPMorgan Small Cap Value A N="MIDDLE">PSOAX 12.20 11.87 18.34 1,000 800-480-4111 Legg Mason U.S. Small Cap Value Prim LMSVX 14.79 13.20 18.26 1,000 800-577-8589 MODERATE ALLOCATION Bruce BRUFX 27.83 43.42 33.40 1,000 800-872-7823 T. Rowe Price Capital Appreciation PRWCX 10.72 12.62 13.64 2,500 800-638-5660 Oakmark Equity & Income I OAKBX 6.24 10.46 13.03 1,000 800-625-6275 EquiTrust Managed FBMGX 7.18 8.90 10.31 250 877-860-2904 Greenspring GRSPX 5.63 10.32 10.18 2,000 800-366-3863 source: morningstar inc. morningstar makes every effort to ensure the accuracy AND COMPLETENESS of this data, but cannot guarantee it. top funds in each category, ranked by FIVE-year returns. open to the public. returns through june 30, 2005. FUND NAME TICKER SYMBOL 1-YEAR RETURN 3-YEAR RETURN 5-YEAR RETURN MINIMUM INITIAL INVESTMENT PHONE WORLD STOCK Polaris Global Value PGVFX 14.75% 17.72% 13.67% $2,500 888-263-5594 Vanguard Global Equity VHGEX 15.29 15.32 9.49 3,000 800-662-7447 Templeton Global Smaller Comp A TEMGX 19.01 16.86 9.41 1,000 800-342-5236 Mutual Discovery A TEDIX 19.52 13.69 9.39 1,000 800-342-5236 Pearl Total Return PFTRX 13.06 12.36 8.92 3,000 866-747-9030 Fidelity Advisor Diversified Intl A FDVAX 14.22 14.03 4.58 2,500 877-208-0098 Marsico International Opportunities MIOFX 7.51 11.55 3.71 2,500 888-860-8686 FOREIGN LARGE GROWTH Fidelity Advisor Diversified Intl B FDIBX 13.22 13.01 3.66 2,500 877-208-0098 Laudus Int'l MarketMasters In SWOIX 14.71 13.46 1.64 2,500 800-435-4000 MFS International Growth A MGRAX 10.53 11.87 0.21 1,000 800-225-2606 FOREIGN LARGE BLEND Fidelity Canada FICDX 29.10 21.96 10.51 2,500 800-343-3548 Exeter World Opportunities A EXWAX 15.40 14.04 7.07 2,000 800-466-3863 Thornburg International Value A TGVAX 15.77 valign="middle">13.29 5.03 5,000 800-847-0200 Vanguard International Value VTRIX 14.94 12.72 3.18 3,000 800-662-7447 Members International Stock A MINAX 18.71 14.09 3.08 1,000 800-877-6089 LONG-TERM GOVERNMENT American Cen. Target Mat 2025 Inv BTTRX 36.56 18.46 13.34 2,500 800-345-2021 American Cen. Target Mat 2020 Adv ACTEX 26.01 15.11 12.28 2,500 800-345-2021 Wasatch-Hoisington U.S. Treasury WHOSX 25.69 12.90 10.99 2,000 800-551-1700 American Cen. Target Mat 2015 Inv BTFTX 16.24 11.78 10.96 2,500 800-345-2021 PIMCO Long-Term U.S. Gov't A PFGAX 15.17 DLE">9.67 10.25 5,000 888-877-4626 INTERMEDIATE GOVERNMENT Vanguard Inflation-Protected Secs VIPSX 9.07 9.21 9.77 3,000 800-662-7447 American Century Inflat-Adj Bd Inv ACITX 8.95 8.63 9.19 2,500 800-345-2021 BlackRock Government Inc Inv A CCGAX 7.01 5.73 8.14 500 800-441-7762 Vanguard Interm-Term U.S. Treas VFITX 6.25 5.73 7.73 3,000 800-662-7447 PIMCO Total Return Mortgage D PTMDX 6.01 4.95 7.38 5,000 888-877-4626 SHORT-TERM GOVERNMENT Managers Intermediate Duration Govt MGIDX 5.33 4.25 6.57 1,000 800-835-3879 Marshall Government Income Inv MRGIX 5.73 4.46 6.10 1,000 800-236-8560 Accessor Mortgage Securities Adv AMSFX 5.15 3.83 6.09 5,000 800-882-9612 American Century Target Mat 2005 Inv BTFIX 1.59 3.24 6.05 2,500 800-345-2021 Allegiant Government Mortgage A ARSAX 5.43 3.87 5.92 500 800-622-3863 LONG-TERM CORPORATE BOND Delaware Extended Duration Bond A DEEAX 16.35 13.91 12.75 1,000 800-362-7500 Vanguard Long-Term Invest.-Grade VWESX 17.76 10.84 10.92 3,000 800-662-7447 Vanguard Long-Term Bond Index VBLTX 16.81 10.97 10.72 3,000 800-662-7447 Lebenthal Taxable Municipal Bond LTMBX 11.36 7.66 9.31 2,500 800-221-5822 Smith Barney Invest. Grade Bond A SIGAX 11.95 8.62 9.16 1,000 800-451-2010 SHORT-TERM BOND Ivy Mortgage Securities A IYMAX 5.52 4.59 7.04 500 800-777-6472 Phoenix Multi-Sector S/T Bd A NARAX 5.49 6.65 6.91 500 800-243-4361 UMB Scout Bond UMBBX 4.08 3.78 5.98 1,000 800-996-2862 Bremer Bond BBNDX 4.77 3.86 5.90 2,000 800-595-5552 Brown Advisory Inter. Income A BIATX 4.19 4.44 5.89 2,000 800-540-6807 HIGH-YIELD BOND Westcore Flexible Income WTLTX 10.35 10.99 9.43 2,500 800-392-2673 Pioneer High Yield A TAHYX 5.76 11.39 9.36 1,000 800-225-6292 Nations High Yield Bond Inv A NAHAX 8.93 13.47 9.12 1,000 800-321-7854 AFBA Five Star High Yield I AFHYX 4.22 9.97 8.91 500 800-243-9865 Calamos High Yield A CHYDX 8.75 11.01 8.74 2,500 800-823-7386 MUNI NATIONAL INTERMEDIATE Harris Insight Tax-Exempt Bond N HXBAX 6.65 5.50 7.24 1,000 800-982-8782 Delaware Tax-Free USA Interm. A DMUSX 8.45 6.28 6.85 1,000 800-523-4640 Evergreen Municipal Bond A EKEAX 8.54 5.88 6.54 1,000 800-343-2898 American Funds Tax-Exempt Bond A AFTEX 7.38 5.41 6.50 250 800-421-0180 Federated Municipal Securities A LMSFX 8.29 5.49 6.39 1,500 800-341-7400 source: morningstar inc. morningstar makes every effort to ensure the accuracy AND COMPLETENESS of this data, but cannot guarantee it. top funds in each category, ranked by five-year returns. open to the public. returns through June 30, 2005.