Great Investments for the Next Downturn

By Shannon Zimmerman

The market's long-term trajectory is up, of course; but, as we've seen in recent days, there are plenty of fits and starts along the way.

Slightly more distant history makes the point much more dramatically. Remember early 2000? During that year, the Nasdaq 100-tracking Cubes (QQQQ) -- an exchange-traded fund (ETF) that recently included Cisco Systems (Nasdaq: CSCO), Biogen Idec (Nasdaq: BIIB), Sun Microsystems (Nasdaq: SUNW), and Juniper Networks (Nasdaq: JNPR) among its holdings -- swooned to the tune of nearly 37%. Investors who plunked down their hard-earned moola on that passive pick in January 2000 are still sitting on a sizable loss -- even after factoring in the market's impressive rise since late 2002.

Investors in more mild-mannered index trackers have fared better. Still, between January 2000 and the close of 2006, Vanguard 500 Index (VFINX) -- an S&P 500 tracker that provides dirt-cheap exposure to the likes of Corning (NYSE: GLW), Applied Materials (Nasdaq: AMAT), and ConocoPhillips (NYSE: COP) -- hardly managed any gains at all.

Never fear

That's hardly adequate compensation for the risk you assume when investing in the stock market, but there's a common-sense way to navigate a sell-off without stuffing your money under a mattress: actively managed mutual funds.

With a stock-picker-in-chief at the helm, an active fund -- unlike an index tracker -- can dodge bullets, preserving your nest egg so that when the market's upswing begins anew, you'll have a bigger pile of loot for the miracle of compound interest to work its magic on.

Funds also make light work of intelligent asset allocation -- another vital technique for playing defense. When you own large caps and small -- as well as value stocks and growth plays -- you've effectively insulated your portfolio. You may not be able to escape a downturn entirely, but you can cushion the blow and have plenty of skin in the game when the storm blows over.

The thing is ...

The vast majority of funds, alas, aren't worth the exorbitant expense ratios they charge, leading many savvy investors to settle for index investing. My advice? Don't do it. Going the indexing route means forgoing the safety net of an active manager. It also means your chances of beating the market are exactly zero: Passive funds are destined to lag their benchmarks by roughly the amount of their annual fees.

To my way of thinking, the better bet is to target active funds with managers who have long and successful track records -- through up markets and down. They should invest their own money alongside that of their shareholders, too. Few mutual fund data points will tell you more than that one. When managers have their loot on the line, after all, they're just as interested in preserving and growing wealth as their shareholders are -- perhaps even more so: In addition to their nest eggs, their jobs depend on it.

The Foolish bottom line

Not coincidentally, whether they "eat their own cooking" is a question I ask the managers I interview for the Fool's Champion Funds investing service. It's also no coincidence that, taken together, our picks have outperformed the market by a double-digit margin.

If you'd like to peek at our winner's list -- and get the inside scoop from world-class money managers who actually earn their expense ratios -- click here for a free Champion Funds guest pass. You'll have 30 days to see if our service is for you. If it's not, no worries: There's no obligation to stick around. But if you're ready to prep your portfolio for the market's all-but-inevitable slumps, my hunch is Champion Funds might be just what you're looking for.