The Case for Mutual Funds vs. Hedge Funds

As more details of the Bernie Madoff investment scandal unfold, plenty of investors feel panicked. After all, if the fat cats were robbed by hedge funds, how can the average investor protect a small account from fraud?

The safest approach is to tuck cash into banks and Treasury bills, but there is another option: mutual funds.

The funds have come through the downturn with their reputation for transparency intact. While Congress is planning investigations of brokers and hedge funds, there are few calls to reform mutual funds. At a time when Lehman Brothers and Bear Stearns have collapsed, major fund companies -- such as Vanguard and T. Rowe Price (TROW) -- remain on sound footing.

To be sure, most funds have suffered sizable losses during the past year. But patient shareholders are likely to recover as the economy revives. That is very different from the thousands of Madoff investors who have lost everything.

This is not the first time that mutual funds have navigated a downturn without suffering a scandal. During the difficult years of 1974, 1987 and 2000, investors faced losses, but there were no cases of major funds robbing shareholders.

Can mutual funds survive a full-blown depression without being tarnished? Some already have. Consider American Funds Investment Company of America (AIVSX), which started in 1934 and is still going strong. During the past 15 years, the fund has returned 7.4% annually, outperforming 81% of large value competitors and beating the S&P 500 by a percentage point, according to Morningstar.

Other Depression survivors that have stayed out of trouble and beaten the S&P 500 during the last 15 years include Fidelity Fund (FFIDX), which was founded 1930, and Pioneer Fund (PIODX), founded in 1928.