As Americans look back at 2011 and look ahead to 2012, many are wondering what to do about their 401(k) retirement accounts and mutual fund investments. After a year like this one — with lots of short-term fireworks but little overall gains for the market — it seems harder than ever to plot a way to get ahead with your 401(k) mutual funds.
Thankfully, you can still find opportunities even in a choppy stock market. You just have to know where to look.
Here are the facts: Many widely held mutual funds will never do anything other than track the market because they’re tied to an index like the Dow Jones Industrials or S&P 500, and chalk up returns in kind. On the other hand, active managers often do even worse than the major indices. A parade of studies and statistics show that the average returns of mutual fund managers lag about one percentage point behind the stock market index that most closely resembles their strategy.
That means to get ahead, you either have to pick a better index to follow — or a better manager to run your 401(k) funds.
With this in mind, here are the 10 best mutual funds to consider for 2012, with two picks each across five distinct investment classes: blue-chip stocks, midsize stocks, small stocks, global investments and bonds.
Best Blue-Chip Stock Funds
Winner: Vanguard Dividend Growth
Vanguard is the leader in low-cost mutual funds, even when you buy a fund with an active manager. Vanguard Dividend Growth Fund (MUTF:VDIGX) has a rock-bottom expense rate of 0.34% — yet continues to outperform its benchmark, the Vanguard Dividend Appreciation Index. This is a good example of a well-run fund that consistently beats “passively managed” investments of a similar strategy.
Most important, that strategy is a good one for a volatile market. Dividend Growth is designed to provide investors with income by picking high-yield stocks across all industries. Current top holdings include Automatic Data Processing (NYSE:ADP) and PepsiCo (NYSE:PEP), which both yield 3%-plus dividends. That means even if the stock flatlines, you’ll get a 3% return on your investment via cash payments every quarter — a perfect way to find profits in a market that may go nowhere for some time.
The fund gets Morningstar’s top five-star rating. Minimum buy-in is $3,000.
Runner Up: Wells Fargo Advantage Growth
A good second choice for IRA accounts or investors with more options is the Wells Fargo Advantage Growth Fund (MUTF:SGROX). This also is an active fund that relies on managers making picks. It’s pricey, with a 1.3% expense ratio, but returns are worth it. The Wells Fargo Advantage Growth fund has tallied double-digit returns in 2011, more than twice the broader market, and over the past five years $10,000 would have grown into $15,000 — while the S&P is largely flat. Past performance is no guarantee of future returns, but these guys have done well picking stocks. This fund also gets Morningstar’s top five-star rating.
Best Midsize Stock Funds
Winner: Scout Mid Cap
Midcap stocks — that is, those with a market capitalization of roughly $1 billion to $8 billion — are attractive to many investors. These are stocks of decent size, from companies that still have significant growth potential ahead.
The trouble, of course, is picking the right stocks in this group amid high volatility, where big losers can offset any big winners in a midcap fund portfolio.
With almost $800 million under management, the Scout Mid Cap Fund (MUTF:UMBMX) is a proven winner when it comes to picking stocks. This fund gets Morningstar’s top five-star rating, and it has a one-year return of over 13%, more than double the market. Its five-year return averages more than 9%, which would have turned $10,000 into $15,000 since 2007 — while the broader market is basically flat.
With market volatility likely to remain high amid sovereign debt woes, high unemployment and the run-up to the 2012 elections, it could be more of the same for midcaps in 2012. That means good managers with a solid track record are key. With a 1.04% expense ratio, the Scout fund is worth the price of admission if it can keep this record of success.
Runner Up: Vanguard Mid-Cap Growth
If you don’t want to trust a manager, keep in mind that many actively managed midcap funds have underperformed the benchmark MSCI US Mid Cap 450 Index in recent years. So why not just buy the index itself via the Vanguard Mid-Cap Growth Index Fund (MUTF:VMGIX)? A rock-bottom expense ratio of 0.26% (plus a $75 transaction fee) gives you a cost-effective way to play midsize stocks.
Best Small Stock Funds
Winner: Fidelity Small Cap Discovery
If you think stock picking is important with midsize companies, it’s even more important with up-and-coming outfits that barely are out of the start-up phase. These smaller companies have virtually limitless potential, but also are more likely to suffer in market shocks or fail completely on missteps.
While previous profits are no promise of gains in 2012, it’s worth noting the very strong performance of Fidelity Small Cap Discovery Fund (MUTF:FSCRX) since its current manager Chuck Meyers took over in early 2006. The fund’s five-year annual return is over 6.5% — and more impressively, since the 2009 market lows, the Small Cap Discovery fund has more than doubled its investors’ money with a nearly 120% return! The broader market is up almost 50%, and small-cap indices like the Russell 2000 are up by over 60%, but that doesn’t hold a candle to this Fidelity pick.
The fund gets Morningstar’s highest five-star rating, and its modest 1.08% expense ratio is one of the best among actively managed small-cap funds. With a long-tenured manager with a history of beating his benchmark, this mutual fund is worth a look.
Runner Up: Intrepid Small Cap
The Intrepid Small Cap Fund (MUTF:ICMAX) bests even the strong performance of Fidelity Small Cap Discovery when you go back five or 10 years. But it has a slightly higher expense ratio of 1.51%, and its current managers have been with the company for only a few years — the oldest dating back to just 2009. So, they can’t take all the credit for the Intrepid fund’s long-term success. On the other hand, the fund has outperformed the benchmark Russell 2000 over the past year and the past three years, and it gets Morningstar’s top five-star rating. So there’s reason to believe success will continue under the current team.
Best International Funds
Winner: Dodge & Cox International
There are eight managers of the Dodge & Cox International Stock (MUTF:DODFX) mutual fund, and normally that would throw up some red flags. Won’t too many cooks spoil any strategy? Won’t that drive up expenses with so many people on the payroll?
Well, the folks at Dodge & Cox seems to be an asset that allows the fund to pick stocks all over the world with due diligence — with holdings now from Germany’s Bayer to Japan’s Mitsubishi. It also helps that half the crew has been managing this fund since 2001, so it’s not like this is just a farm team for would-be asset managers. The returns of almost 10% annually on average in the past decade prove these folks know their stuff — more than doubling client money over the past 10 years. The benchmark MSCI EAFE Index — that’s Europe, Australasia and the Far East — is up by half as much.
To top it off, expense ratios are low at 0.65% — very reasonable among actively managed global funds, even with a $75 transaction fee. The fund gets four stars from Morningstar.
Runner Up: TCW Emerging Markets Income
TCW Emerging Markets Income Fund (MUTF:TGINX) invests in bonds of emerging-market countries like Venezuela, Brazil and even Nigeria. Though there obviously is higher risk in government or corporate debt in these regions, the returns also can be much higher — sometimes a yield of double digits. The fund’s long-term track record speaks for itself, averaging over 10% annualized returns in the past 10 years — which would have more than doubled your money. The expense ratio is a bit higher at 1.25%, and the risk obviously is greater, but the profits speak for themselves.
Best Bond Funds
Winner: PIMCO Total Return
PIMCO and its bond fund manager, Bill Gross, got some bad press this year thanks to a disappointing start to 2011. Gross admitted it was a boneheaded move to dump U.S. Treasuries just before bonds started to rally strongly. But you can forgive Gross based on the market turmoil, government mayhem in Washington — and of course his impeccable long-term track record.
You also can be sure that Gross and the PIMCO Total Return Fund (MUTF:PTTDX) will be back with a vengeance in 2012. The mutual fund maintains its Morningstar five-star rating and has returned more than 6% annually during the past five-year and 10-year periods, even accounting for a mostly flat 2011.
With a modest expense ratio of 0.75% and one of the icons of bond investing at the helm since 1987, PIMCO Total Return is a good fit for almost every portfolio in 2012.
Runner Up: BlackRock High Yield
“Junk bonds” scare many investors these days because of their greater likelihood to default in an already tumultuous economic environment and difficult market for corporate and government debt offerings. However, when done right, you can find enough big winners to offset any losers — and that’s exactly what the BlackRock High Yield Bond Fund (MUTF:BHYSX) has a history of doing. Garnering yields sometimes in the double digits on its bonds, BlackRock has more than doubled its investors’ money in the last decade — versus a measly 10% total gain for the broader stock market. The fund gets Morningstar’s top five-star rating and has a modest 0.75% expense ratio.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks. Check out InvestorPlace.com’s other looks back at 2011 and ahead to 2012 here.