For many people, the perfect investment in today's difficult markets would combine the strong long-term returns of a top mutual fund and the protection against losses offered by some annuities.

In the real world, no such optimum vehicle has existed -- but that could be changing. Now, financial engineers are tinkering with the standard formats, developing hybrids that include mixes of features.

The distinction between annuities and funds is normally clear. While annuities include expensive insurance contracts that can protect assets, mutual funds are cheaper and come with no guarantees. The latest creations include annuities that resemble funds and funds with annuity-like protections. Eventually the line between annuities and funds could disappear altogether.

One mutual fund with elements of an annuity is DWS Lifecompass Income. Investing in a mix of stocks and bonds, the portfolio began in December 2007 with the aim of paying out regular income for the next ten years. Shareholders receive 8.25% of their initial investment annually. At the end of the 10 years, investors get any assets remaining in the portfolio.

If the investments perform poorly, the portfolio could be depleted before the decade ends. But DWS promises to make all the scheduled annual payments and deliver a final installment equal to at least 17.5% of the initial principal. In other words, the fund company pledges to return at least the principal over the course of 10 years.

Critics may contend that the DWS goal is modest. But the approach represents a dramatic step for the fund industry, which has rarely been willing to stand behind its products. Investors who watched their stocks plummet this year could be intrigued by a mutual fund that promises not to lose money.

Recognizing the desire for security in the current erratic markets, some employers are now offering a mix of funds and annuity-like choices in 401(k) plans. In a typical program run by

MetLife

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, a plan participant can choose from among half a dozen stock and bond funds. In addition, there is an annuity-like offering called Personal Pension Builder, which delivers income for life. MetLife participants can put some of their contributions into mutual funds and some into the lifetime income choice.

Under the MetLife system, a saver can know exactly how much he needs to contribute in order to receive a fixed income. If a 45-year-old puts $100 a month into the annuity-like choice, he could retire at 65 and receive $314 a month for life, regardless of how markets perform.

Half a dozen insurers have begun offering the lifetime income choices, and more are scheduled to enter the field.

"So far the annuity-type products are a small factor, but eventually they could account for a significant percentage of 401(k) assets," says Robyn Credico, a retirement consultant for Watson Wyatt.

Among the most common investments with guarantees are variable annuities. Like mutual funds, these invest in portfolios of stocks and bonds. Returns depend on market results.

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Up to now, many financial advisers have been reluctant to recommend variable annuities because of their high fees. Investors in annuities typically pay two levels of fees. First, there are management fees, which resemble the expense ratios of mutual funds and cover costs of running portfolios. Typical management fees are about 1.2% of assets. In addition, annuities come with annual fees of about 1.40% that cover insurance and sales costs; mutual funds charge no such insurance fees.

For the extra costs, annuity investors obtain a tax shelter. Earnings in an annuity are not taxed until investors take withdrawals. In addition, annuity owners have the right to convert their holdings into vehicles that provide lifetime income.

To compete more effectively with mutual funds, some annuity companies have been chopping their fees. Jefferson National now sells an annuity that comes with a flat fee of $20 a month. The fee is the same, regardless of the size of the investment.

"If you invest, $50,000, the fee is less expensive than what 99% of variable annuities charge," says Deborah Newman, Jefferson National's director of communications. "If you invest $1 million, the fee is a tiny percentage of the assets."

Investors in the Jefferson National annuity can select from among 200 different portfolios, which are managed by well-known companies, such as PIMCO and

T. Rowe Price

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.

To appreciate the appeal of the annuity, consider a shareholder who wants to invest in

Vanguard Total Stock Market

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, an index mutual fund that charges an annual expense ratio of 0.15%. Instead of buying the no-load fund, the investor could opt for a Jefferson National annuity and elect to have the money placed in a Vanguard total market portfolio. The investor would pay an annual expense ratio of 0.16% and $20 a month for the insurance fee.

Why should you buy the annuity and pay an extra monthly fee? By taking the annuity, the investor can avoid paying taxes for years -- and has the right to convert the investment to fixed payments for life.

So far, only a handful of companies offer low-cost annuities. But there will soon be more choices that mix the qualities of funds and annuities. At a time when investors crave security, financial companies are rushing to find investments that can deliver solid returns and peace of mind.

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.