Fund Observer

When the dot-com bubble burst in early 2000, most investors thought the mutual fund industry couldn't sink any lower. Ten years and two recessions later, it now appears that they slightly misjudged the situation. In fact, for fund investors, this decade has been defined by a seemingly unending stream of blunders and disasters. Here are 10 of the worst:

[Slide Show: The Decade's 10 Worst Mutual Fund Disasters.]

The Reserve Primary Fund. On September 16, 2008, the iconic Reserve Primary Fund's price dipped below $1 per share, shattering the notion that money market funds couldn't lose money. As investors dashed to cash in their shares, the fund had to put a freeze on redemptions. Meanwhile, the panic quickly spread throughout the entire money market sector, and funds suddenly found themselves struggling to stay afloat. On September 19, the federal government announced a plan to temporarily insure money market funds, and only then did investor confidence begin to rebound. Ultimately, the Reserve Primary Fund's biggest blunder was putting too much faith in Lehman Brothers. When Lehman went under, the fund was left hanging on to $785 million in suddenly worthless bonds. Jeff Tjornehoj, Lipper's research manager for the United States and Canada, calls the fund's entanglement with Lehman Brothers an example of managers "trusting their instincts over their investing discipline." Even today, the Reserve Primary Fund debacle continues to mar the money market sector's reputation, and drawn-out courtroom proceedings during which investors angle to recover their losses have done little to reduce the incident's high-profile nature. On the bright side, investors are expected to eventually recover 99 cents on the dollar.

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In a field of about 8,000, very few mutual funds truly stand out. But every so often, you'll stumble across some that are destined for the record books. Here are four of them:

Oldest Fund: MFS Massachusetts Investors Trust (MITTX)

The story: The Massachusetts Investors Trust, launched in 1924, is America's first and oldest mutual fund. In July 1924, its holdings included Island Creek Coal, Punta Alegre Sugar, General Motors, Union Pacific Railroad, and Edison Electric of Boston. One of its larger positions at the time was a whopping three shares of Boston Insurance Co., which was trading at $682 per share. General Motors, meanwhile, was trading at $13 per share, so the fund's managers scooped up 50 shares. The fund, which aimed to give average investors access to the market, was tested five years after its inception by the onset of the Great Depression. It stuck with its conservative strategy and has put up solid numbers since. So far this year, the fund is up 27 percent. Its annualized return over the past 10 years is 0.5 percent.

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Looking back at the market over the past few years, it appears that the band Radiohead was particularly prescient when it declared that "down is the new up." That's because at some point during the downturn—nobody knows exactly when—being unfashionable became the most fashionable thing an investor could do. 

Fortunately, for those who keep track of buzzwords, this phenomenon even has a nifty name: contrarian investing. This strategy, which involves taking a skeptical view of market trends, is hardly a recent invention—longtime practitioners include Warren Buffett and Legg Mason's Bill Miller—but it appears to have become increasingly popular as of late. And as mutual fund managers and average investors alike jump onto the contrarian bandwagon, something quite paradoxical has happened: By nature of becoming a bandwagon, it's no longer contrarian. Contrarian, it seems, is almost becoming the new normal.

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Funds that invest in dividend-paying stocks won't "wow" investors with eye-popping returns during bull market rallies, but their added yield over time can provide some cushion in devastating bear market drops. From 1926 to March 2009, 44 percent of the total returns of the S&P 500 came from reinvested dividends, according to S&P data. Some blue-chip stocks consistently pay out dividends year after year, and although they can cut their dividends at any time (as many financial companies have), mutual funds that invest in dividend-paying companies can pick and choose to provide a steady stream of income over time.

[See 10 Great Dividend Stocks.]

Stock funds generally aim for capital appreciation, a steady growth of income, or a combination of both. Capital appreciation is what investors generally think of when it comes to returns, but a stable income on the side can be helpful in periods when markets are falling or at a standstill. "There's the capital appreciation, which usually is the bigger component of your total return, and there's also the income portion," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada. "The income portion can really hold you in good stead when the market just isn't moving anywhere."

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