The first six months of 2006 offered little encouragement for mutual fund investors. Stock funds rose in the first quarter then sank in the second, winding up with average returns around 3% for the period. On the bond side, investors barely broke even as their income distributions were offset by falling share prices in the face of rising interest rates. To guard against such times of sluggishness and possible market corrections, Kaye and Nick Flores of Altadena, California, spread their assets around. "Counting our retirement plans, the money held in taxable accounts, and the money in our children's accounts, we hold 14 different funds," says Kaye, 44, a marketing executive at a healthcare firm. The Floreses have been investing in mutual funds since the 1980s. "We invest in our funds three times each month," says Kaye. "That includes the money I invest at work, in the 403(b) plan." This plan, similar to a 401(k), allows her to defer some income (and some income tax) by putting money into a mix of funds. "We don't really miss the money we're investing," she says, because the outlays become just like any other item in the family budget. The couple picks their funds with the help of Arnetta Tolley, an investment adviser at the Pasadena, California, office of Edward Jones Investments, a financial services firm based in St. Louis. "We meet with her once each quarter," says Nick, 46, a semi-retired network engineer who is launching a new business, N.S. One Spa and Salon, in Altadena. "We may bring in funds for her opinion, or she might recommend some funds for us." The Floreses currently have some 85% of their mutual fund assets in stock funds while 15% is in fixed-income and cash. Among the stock funds, 49% is in growth, 36% is in growth-and-income, and 20% is in global and international funds. They own a number of American Funds products including EuroPacific Growth Fund, which focuses on the largest international companies, and are increasing their ownership in New Perspective Fund, which invests in both U.S. and foreign stocks. The emphasis at New Perspective is on multinational companies that stand to gain from changes in international trade patterns, according to Tolley. The couple also owns Capital World Growth and Income Fund, which is a "conservative cousin" of New Perspective. Other holdings include The Investment Company of America, Fundamental Investors, and The Growth Fund of America, all of which emphasize domestic stocks. Though the results for the first half of 2006 may have been unexciting, they could have been much worse. As of early August, there had not been a market correction -- a decline in market price of at least 10%, but no more than 20% -- in more than two years. But today's triple threats of higher interest rates, inflation, and energy costs make such a correction a strong possibility in 2007. In times like these, where can you turn to get sustained mutual fund performance? While it's hard to predict which types of funds will do well, John Coumarianos, an analyst at Morningstar Inc., recommends investing in mutual funds that are diversified among different asset classes emphasizing past performance and experienced management. Coumarianos recommends looking into foreign stocks. Morningstar's category of Pacific/Asia stock funds that excludes Japan was up 13.68% in the first half, followed by Latin American (13.20%) and European (13.14%) stock funds, as investors continued to find better values and opportunities outside the U.S. Foreign stock funds have outperformed domestic entries every year since 2001. Other categories investors should consider include: Precious metals. These types of funds were the big winners, gaining 22.50% in the first half of this year. They invest heavily in mining stocks, especially gold mines. "Gold is viewed as an inflation hedge," says Coumarianos. Inflation worries have contributed to higher gold prices in recent years; higher gold prices, in turn, have boosted the share prices of mining companies and the mutual funds owning their stocks. Real Estate/Energy. Strong returns also were posted by real estate funds (up 12.44%) and natural resources funds (11.95%), which have large holdings of energy stocks. Real estate, oil, and natural gas are all expected to gain value in inflationary times, so these funds were popular. If you're worried about a correction in 2007 driven by higher inflation, you might want to hold such funds in your portfolio. Small companies. Among domestic funds, the small-value and small-blend (which hold a mix of small-company growth and value stocks) categories led the way, both gaining about 7% in the first half. While the superior performance of precious metals, real estate, and natural resources funds can be attributed to inflation concerns, what explains the strong results from foreign stocks and, to a lesser extent, small U.S. companies? After all, even the domestic giants struggled much of the year. Funds holding large-company growth stocks, the darlings of the 1990s bull market, lost more than 1% in 2006, through June. "We're still seeing some rebound from the late 1990s," says Coumarianos. "Back then, investors invested heavily in large growth stocks, especially tech stocks. Foreign stocks and small-cap stocks were all but forgotten, so they became undervalued." The bear market of 2000 to 2002 demolished tech stocks, so investors turned to small caps and foreign stocks, trends that continue to run. "Some foreign companies, especially in Asia and Latin America, participate in metals, mining, or oil," says Coumarianos. "Those industries are attracting investors now after many years of neglect." In addition, investors learned the risks of overloading on one type of mutual fund, so diversification into lesser-known areas has gained popularity. Proverbial Profits Another fan of American Funds is Kevin Davis, a certified financial planner with Consolidated Financial Services in Dallas. "I used to be a recruiter," he says, "and I heard that it was hard to place money managers with that company. Only the top people got jobs there." Such selectivity has resulted in investment success. "The funds might be the turtle rather than the hare," says Davis. "They may not have the best returns in any one year, but they'll finish first over a long race." Among Davis' clients hoping to reach the winner's circle is Lawrence Powell, 42, senior pastor of Agape Family Worship Center in Rahway, New Jersey. "We have three children, ages 11 to 15, so some of my investing is intended to help pay college bills," he says. "At the same time, I'm investing for my own retirement, which is long-term. And I'd like to leave an inheritance, too. As it says in Proverbs 13:22, 'A good man leaves an inheritance for his children's children.'" To accomplish these multiple goals, Powell invests in mutual funds through his employer's 403(b) plan, where he has been maximizing contributions, and also invests in tax-advantaged 529 college savings plans for his children. "I'm mainly using stock funds for my retirement," he says, "because the long-term returns are likely to be greatest there. But I'm somewhat conservative with the funds in the college account." Powell was an even more conservative investor up until a few years ago. "I explained that he has about 20 years until retirement," says Davis, "and he can live for many years after that, so he really needs to invest with a long time horizon. Therefore, we have increased his stake in stock funds." Historically, the long-term results from stock funds top those from bond funds. Some of the American Funds on Powell's list are the same as those held by the Floreses: Growth Fund of America, Capital World Gr owth and Income, Fundamental Investors, and New Perspective. But there are others as well. "Lawrence invests in New World and SMALLCAP World funds," says Davis, "to get a good mix of non-U.S. stocks. Companies are doing well overseas, so investors can feel more comfortable with international funds." On the domestic side, Powell also has AMCAP Fund, which holds large-growth stocks. "In addition, he invests in American Balanced Fund," says Davis, "which is more conservative because it holds bonds as well as stocks." What funds might appeal to investors who are worried about a correction next year? "Funds that tend to do better during market corrections are those that focus on providing income as part of their overall objective," says Davis. "Such funds may be found in the growth-and-income, equity income, and balanced categories." Davis' list of funds that have done well during previous market corrections include American Balanced, as well as The Income Fund of America and Capital Income Builder, two funds that hold dividend-paying stocks and bonds. (The latter fund has more global exposure.) Davis also cites American Mutual Fund and Washington Mutual Investors Fund, two stock funds that hold large companies likely to pay dividends. "As always," he says, "part of a good investment program to offset market corrections would be a diversified portfolio that is not overweighted in any one industry." In Search Of Income It's no surprise that interest rates are rising and are expected to continue doing so in the coming year. Coumarianos says investors should keep some money in bond funds even though the rising rates should devalue bonds. "An intermediate-term bond fund can be a core holding," he says, "offering reasonable income with moderate risk. Funds such as PIMCO Total Return Fund and Fidelity Intermediate Bond Fund may be good choices." PIMCO Commodity RealReturn Strategy Fund also rates a favorable mention from Coumarianos. "It tracks the Dow Jones AIG Commodity Index so you get broad exposure to commodities, including oil and gas," he says. Coumarianos also says there's value in large-cap domestic stocks, particularly those companies who have protected their competitive positions. His picks in the large-cap growth area include T. Rowe Price New America Growth, Vanguard Growth Equity Fund, and USAA Aggressive Growth. In the large-cap value category, picks include ICAP Select Equity Fund, Sound Shore Fund, and Weitz Value Fund. A well-diversified mutual fund portfolio for these uncertain times should include old reliables such as large U.S. companies and high-quality bonds as well as new favorites that range from foreign stocks to small companies. A small (perhaps 5%) allocation to commodities and a similar allocation to a real estate fund might provide valuable protection in case inflation heats up and the market turns down. Although inflation fears and geopolitical concerns have shaken stock markets lately, Tolley has little inclination to cut back on stocks in anticipation of a possible correction, especially for investors who are in it for the long haul. "When stock prices fall," she says, "there are buying opportunities. At any kind of store, when is the best time to go shopping? During the semi-annual sales." B.E.'s best-performing Mutual funds FUND NAME TICKER SYMBOL 1-YEAR RETURN 3-YEAR RETURN 5-YEAR RETURN MINIMUM INITIAL INVESTMENT PHONE LARGE GROWTH Marsico 21st Century MXXIX 23.41% 20.65% 12.93% $2,500 888-860-8686 Columbia Marsico 21st A NMTAX 22.63 20.47 12.52 1,000 800-321-7854 Amana Trust Growth AMAGX 19.81 21.74 8.40 250 800-728-8762 Fidelity Fifty FFTYX 18.56 10.16 7.61 2,500 800-343-3548 Dreyfus Prem Alpha Gr C BSFCX 16.35 13.23 7.45 1,000 800-554-4611 MID GROWTH Delaware American Ser A DASAX 11.35 17.32 14.37 1,000 800-523-1918 Baron Partners BPTRX 20.06 29.89 14.37 2,000 800-442-3814 Columbia Acorn Z ACRNX 16.44 21.94 12.31 75,000 800-345-6611 Columbia Acorn Select Z ACTWX 17.28 15.89 11.75 50,000 800-345-6611 Munder Mid-Cap Core Gr Y MGOYX 12.41 20.28 10.82 1,000,000 800-438-5789 SMALL GROWTH Royce Value Plus Service RYVPX 30.00 28.78 22.75 2,000 800-221-4268 William Blair Sm-Cp Gr N WBSNX 11.75 20.82 14.16 5,000 800-635-2886 UMB Scout Small Cap UMBHX 16.16 20.30 12.35 1,000 800-996-2862 Excelsior Small Cap UMLCX 18.03 20.67 11.97 500 800-446-1012 First Amer Sm Cap Sel Y ARSTX LIGN="MIDDLE">21.93 "MIDDLE">20.24 11.15 0 800-677-3863 LARGE BLEND MassMutual Sel Foc Val S MFVSX 4.43 11.72 10.98 1,000,000 888-309-3539 Penn St Adv Sect Rot A PSRPX 12.95 17.24 9.75 2,000 866-207-5175 Janus Contrarian JSVAX 22.05 23.56 9.73 2,500 800-525-3713 CGM Mutual LOMMX 13.62 18.67 9.11 2,500 800-343-5678 Mairs & Power Growth MPGFX 8.03 13.00 9.05 2,500 800-304-7404 MID BLEND Fidelity Adv LevCo Stk A FLSAX 18.65 27.14 24.64 10,000 877-208-0098 Fidelity Leverage Co Stk FLVCX 20.58 valign="middle">27.77 24.27 10,000 800-343-3548 CGM Focus CGMFX 26.45 29.43 21.11 2,500 800-343-5678 RS Value RSVAX 10.68 25.93 17.59 5,000 800-766-3863 Kinetics Paradigm WWNPX 20.67 24.31 16.56 2,500 800-930-3828 SMALL BLEND Bridgeway Ul-Sm Co Mkt BRSIX 15.07 21.65 22.35 2,000 800-661-3550 Keeley Small Cap Value KSCVX 31.10 29.79 18.02 1,000 888-933-5391 Royce Value Service RYVFX 22.15 26.44 17.16 2,000 800-221-4268 Stratton Small-Cap Value STSCX 16.21 25.54 16.72 2,000 800-472-4266 Pacific Adv Small Cap A PASMX 44.49 39.03 16.62 1,000 800-989-6693 LARGE VALUE Yacktman Focused YAFFX 3.68 9.28 14.51 2,500 800-525-8258 Yacktman YACKX 3.82 9.82 13.47 2,500 800-525-8258 Hancock Horiz Value Tr HHGTX 16.13 20.12 11.80 1,000 800-259-1926 Fidelity Adv Cyclical Indst A FCLAX 22.33 24.34 11.55 2,500 877-208-0098 Pioneer Cullen Value A CVFCX 14.73 19.20 11.16 1,000 877-485-8586 MID VALUE ICON Materials ICBMX 35.29 31.37 16.63 1,000 800-764-0442 Nuveen NWQ Multi-Cp Val R NQVRX 17.77 20.15 14.51 3,000 800-257-8787 Alliancebern Sm-Mid Cap Val A ABASX 12.19 19.83 14.23 2,500 800-221-5672 Delafield DEFIX 15.18 18.43 13.73 5,000 800-221-3079 Quaker Mid-Cap Value A QMCVX 10.32 22.80 13.61 2,000 800-220-8888 SMALL VALUE James Small Cap JASCX 15.59 22.98 18.00 2,000 800-995-2637 DFA U.S. Small Cap Value II DFAVX 20.13 26.83 16.94 2,000,000 310-395-8005 Mainstay Small Cap Opp I MOPIX 9.91 25.41 16.92 5,000,000 800-624-6782 Pacific Cap Small Cap A PCSAX 15.76 23.57 >16.68 1,000 800-258-9232 DFA U.S. Small Cap Value DFSVX 19.77 26.50 16.66 2,000,000 310-395-8005 MODERATE ALLOCATION Bruce BRUFX 19.98 35.59 30.82 1,000 800-872-7823 Waddell & Reed Adv Asset Stat A UNASX 38.80 20.37 12.68 500 800-366-5465 Ivy Asset Strategy C WASCX 36.08 18.88 11.60 500 800-777-6472 ING T. Rowe Price Cap App S ITCSX 9.74 14.15 10.49 0 800-366-0066 T. Rowe Price Cap Apprec PRWCX 9.09 13.22 10.12 2,500 800-638-5660 WORLD STOCK FUND NAME TICKER SYMBOL 1-YEAR RETURN 3-YEAR RETURN 5-YEAR RETURN MINIMUM INITIAL INVESTMENT PHONE Polaris Global Value PGVFX 19.00% 23.15% 16.83% $2,500 888-263-5594 Oakmark Global I OAKGX 20.47 20.73 16.52 1,000 800-625-6275 Templeton Global Sm Co. A TEMGX 14.10 24.51 14.71 1,000 800-342-5236 Vanguard Global Equity VHGEX 22.33 22.96 13.55 3,000 800-662-6273 Evergreen Glob Opport A EKGAX 29.16 28.61 12.90 1,000 800-343-2898 FOREIGN LARGE GROWTH Columbia Marsico Intl Opp Z NMOAX 32.65 23.01 13.31 1,000 800-321-7854 Fidelity Adv Div Intl A FDVAX 25.78 23.35 13.01 2,500 877-208-0098 Marsico Intl Opp MIOFX 31.62 22.94 12.97 2,500 888-860-8686 Principal Inv Intl Gr Instl PITIX 31.85 27.17 12.57 0 800-547-7754 Janus Overseas JAOSX 52.33 33.29 11.83 2,500 800-525-3713 FOREIGN LARGE BLEND Fidelity Canada FICDX 27.34 27.87 18.98 2,500 800-343-3548 Allianz NACM Intl Instl NAISX 39.76 31.33 16.20 5,000,000 800-927-4648 Alliancebern Intl Gr A AWPAX 25.11 27.30 14.56 2,500 800-227-4618 Rochdale Atlas RIMAX 32.24 27.32 13.89 1,000 800-245-9888 Fidelity Intl Disc FIGRX 26.99 25.46 13.10 2,500 800-544-6666 LONG-TERM GOVERNMENT American Cen. Target Mat 2025 Inv BTTRX -12.65 3.42 8.94 2,500 800-345-2021 American Cen. Target Mat 2020 Adv BTTTX -9.48 2.34 8.45 2,500 800-345-2021 American Cen. Target Mat 2015 Inv BTFTX -5.84 1.37 7.51 2,500 800-345-2021 valign="middle">Wasatch-Hoisington U.S. Treasury WHOSX -10.65 1.93 6.77 2,000 800-551-1700 PIMCO Long-Term U.S. Gov't In PGOVX -7.18 1.35 6.70 5,000,000 800-927-4648 INTERMEDIATE GOVERNMENT American Cen. Target Mat 2010 Inv BTTNX -2.10 0.48 5.85 2,500 800-345-2021 Huntington Mtg Sec Tr HMTGX 0.97 4.03 5.44 1,000 800-253-0412 DFA Intermediate Govt F/I DFIGX -2.22 0.75 5.42 2,000,000 310-395-8005 BlackRock Govt Inc Inv A CCGAX -2.03 1.27 5.37 1,000 800-441-7762 PIMCO Total Return Mortgage Inst PTRIX 0.33 3.09 5.28 5,000,000 800-927-4648 SHORT-TERM GOVERNMENT Federated Mortgage Inst FGFIX 0.14 2.44 4.43 100,000 800-341-7400 Analytic S/T Gov Inc Inst ANSTX 1.80 2.64 4.42 2,500 866-777-7818 Managers Interm Dur Govt MGIDX -0.16 2.25 4.37 2,000 800-548-4539 Marshall Govt Inc Inv MRGIX 0.46 3.07 4.35 1,000 800-236-3863 Allegiant Govt Mortgage I AUSIX -0.02 2.32 4.08 0 800-622-3863 LONG-TERM CORPORATE BOND Loomis Sayles Invm Gr F/I LSIGX 3.52 6.66 11.02 3,000,000 888-226-9699 Delaware Extended Duration Bond A DEEAX -6.70 3.40 8.44 1,000 800-362-7500 Croft-Leominster Income CLINX 0.75 4.30 6.69 2,000 800-551-0990 Vanguard Long-Term Bond Index VBLTX -6.79 1.91 6.61 3,000 800-997-2798 Vanguard Long-Term Invest.-Grade VWESX -7.70 1.96 6.61 3,000 800-997-2798 SHORT-TERM BOND Phoenix Multi-Sector S/T Bd A NARAX 1.58 3.23 5.33 500 800-243-4361 Thompson Plumb Bond THOPX 0.95 2.85 4.94 2,500 800-999-0887 BlackRock Interm Bd Instl PNBIX 0.18 1.49 4.73 2,000,000 800-441-7762 Ivy Mortgage Securities A IYMAX 0.17 2.32 4.55 500 800-777-6472 Diversified Short HorInstl DISHX 1.94 3.52 4.39 5,000 800-755-5801 HIGH-YIELD BOND Loomis Sayles Instl Hilnc LSHIX 8.99 14.11 13.22 3,000,000 888-226-9699 Fidelity Real Est H/I F0000U* 6.40 11.25 12.32 2,000,000 800-544-8888 Delaware Pooled High-Yield DPHYX 5.58 11.00 11.82 1,000,000 800-231-8002 WM High Yield A CPHYX 10.66 10.76 11.25 1,000 800-222-5852 VALIC II High Yield Bond F06PMT* 9.94 13.28 11.10 0 800-448-2542 MUNI NATIONAL INTERMEIDATE Phoenix Ins Tax-Ex Bond Instl HXBIX 0.83 2.62 5.26 100,000 800-243-1574 Evergreen Intm Muni Bd Instl ESTIX -0.25 2.90 5.13 1,000,000 800-343-2898 Delaware Tax-Free USA Interm. A DMUSX 0.58 3.32 5.11 1,000 800-523-1918 Elfun Tax-Exempt Income ELFTX 1.02 3.17 4.98 500 800-242-0134 Vanguard Hi-Yld T/E VWAHX 1.77 4.03 4.93 GN="MIDDLE">3,000 800-997-2798 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, 2006. *Identifiers assigned by morningstar for funds with no exchange-assigned tickers. Top funds in each category, ranked by FIVE-year returns. open to the public. returns through june 30, 2006. Â Â