5 huge funds failing your 401(k)

Dodge & Cox Stock

This large-capitalization value fund, a top performer over the past 15 years, has tumbled into the 81st percentile this year with a loss of 41%. Like Fidelity Magellan, it has been punished for moving early and heavily into financial stocks, including deeply troubled Wachovia (WB, news, msgs) and American International Group (AIG, news, msgs). Also like Magellan, the fund has about 20% of assets in distressed foreign stocks.

The fund's problems, however, are the flip side of its strength: a determined, even stubborn team of managers who don't follow the herd. This fund's returns are never approximately what the market delivers -- they are usually much more, as they were from 2000 through 2006, or much less, as they were in the late 1990s and have been since 2007.

Meanwhile, the fund itself is a model of the kind of stewardship you want from your money managers. The expense ratio is 0.52%, one-third the average, and the managers have considerable assets invested in the fund. Morningstar analyst Laura Pavlenko Lutton says, "We urge investors to set fear aside, focus on the long term and allow these fund managers to execute their tested investment strategy."

Fidelity Small Cap Independence

While the other funds in this article have assets in the tens of billions, this fund has only $1.65 billion. For a small-cap fund, however, that is enormous, making this one of the largest offerings in its group. It has also been a good performer -- until recently.

Down 49.2% so far in 2008, Independence has been punished mainly by bad sector bets: a heavy push into energy at the wrong time and underweighting in groups such as health care that have fared better. Morningstar analyst John Coumarianos, writing about the fund in September, said manager Rich Thompson, in place just three years, hasn't been able to maximize Fidelity's prized advantage over other fund complexes: the industry's biggest and brightest stable of stock analysts.

"What we dislike about this fund," he says, "is Thompson's lack of conviction in his individual picks. Currently the fund maintains 193 holdings, 120 of which are less than 0.5% of assets."

Dodge & Cox Stock, by contrast, owns only about 80 names and packs nearly a third of its assets into the top 10 positions. Coumarianos concludes, "We don't see the conviction required to help this fund outperform a low-cost index fund over time."

Vanguard Total International Stock

This low-cost index fund has indeed outperformed more than 80% of similar funds over the past decade, but this year it has slipped into the bottom half in terms of performance, down 48.1%. You can't blame the managers: Like all indexers, they blindly follow their benchmark, which in the case of this fund is a blend of the two leading MSCI foreign-stock indexes: EAFE and emerging markets.

Rather, the fault lies with indexing itself. Unlike active managers, indexers are unable to avoid oncoming train wrecks. Active managers can underweight sectors and regions with particular problems and seek refuge in stronger corners of their marketplace. Indexers cannot. So although this fund's expense ratio is 0.27%, about 80% less than the average for its type, it hasn't been able to avoid the damage that has been so extensive across all the markets and companies it embraces.

But by the same token, since it beats most of its rivals most of the time, this fund is an outstanding long-term choice and is currently priced at rock-bottom. It is among the most attractive mutual funds in today's marketplace.

The fund industry is compelled to warn investors that past performance is no indication of future results. But top-performing funds do tend to preserve their outperformance, albeit not perfectly. When good funds turn bad, it pays to find out why. Most of the time, it's nothing to worry about. But when it is, it's also time to act.

Funds are a product, not a spouse. Don't fall in love with them.

At the time of publication, Tim Middleton owned shares of the following fund mentioned in this article: Dodge & Cox Stock.

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