NEW YORK ( TheStreet) -- With markets climbing lately, investors have been putting cash into stock mutual funds. Plenty of Wall Street analysts are encouraging the optimism, arguing that the economy is bound to accelerate. Maybe so. But as Washington and Europe struggle with debt burdens, the road ahead is bound to have rough patches.

To limit risks, consider adding a cautious fund to your portfolio. Top choices include

Buffalo Flexible Income

(BUFBX) - Get Report


Sierra Core Retirement

(SIRAX) - Get Report

, and

Weitz Balanced

(WBALX) - Get Report

. The funds hold mixes of stocks and bonds, seeking to protect shareholders in downturns. Most often the cautious approaches have worked. All three funds shined during the turmoil of 2008, and they have outdone the

S&P 500

by a wide margin during the past five years.

Sierra Core Retirement aims to avoid losing more than 4% in any downturn. So far the fund has succeeded. While the S&P 500 lost 37% in 2008, Sierra only declined 3.3%. During the past five years, Sierra has returned 8.1% annually, surpassing the S&P 500 by 3 percentage points.

Sierra invests in other mutual funds. Portfolio manager Ken Sleeper holds a mix of stock and bond funds, shifting the allocation as market conditions change. He looks for funds that excel in up and down markets.

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Sierra can hold up to 40% of assets in stocks, but lately, Sleeper has moved away from stocks entirely. Instead, he has a big stake in high-yield bond funds. Holdings include

Neuberger Berman High Income

(NHIAX) - Get Report

. Sleeper acknowledges that high-yield bonds have rallied in recent years, but he says that they still yield 6%, a tempting payout at a time when the S&P 500 yields 2.0%.

When stocks rise, high-yield bonds also tend to climb, he says. This occurs because investors bid up bond prices as the economic outlook improves and default risk declines. In downturns, high-yield bonds typically lose less than equities. "With high-yield funds, you can get equity-like returns without all the risk," Sleeper says.

Sleeper also owns high-yield municipal bond funds, such as

Nuveen High Yield Municipal

(NHMRX) - Get Report

, which yields 6.0%. For safety he has some high-grade funds including

Vanguard GNMA

(VFIIX) - Get Report

, which holds government-backed issues.

Even conservative bond funds can lose money sometimes. To limit risks, Sleeper uses a stop-loss strategy. If any of the bond funds lose more than 2% or 3%, he sells and shifts to cash. The stop-loss approach kept the fund afloat in 2008. Sleeper concedes that his cautious strategy will lag the S&P 500 in a bull market, but he says clients are willing to forgo big gains. "Our clients typically are over 55, and they do not want much downside risk," he says.

Weitz Balanced aims to provide a steady ride by sticking with a mix of solid value stocks and high-quality fixed income. In 2008, the fund surpassed the S&P 500 by 11 percentage points. During the past five years, Weitz returned 5.4% annually.

Portfolio manager Bradley Hinton typically holds from 40% to 70% of assets in equities. In 2010, the fund had 60% of assets in stocks. But since then Hinton has lowered the stock allocation as prices have risen. Today he only has 46% of assets in stocks. "There are not a lot of compelling bargains around," he says.

Hinton favors stocks that sell at 40% discounts to their fair values. To find cheap prices, he considers companies that appear to have problems. A favorite holding is


(APA) - Get Report

, a producer of oil and gas. Hinton says that the stock is undervalued because the company has a big stake in Egyptian gas fields. Investors have been unnerved by the country's political uncertainty. Hinton says that most of the company's production is in the U.S. and other stable areas. While the stock currently trades for around $84, he says that the shares are worth $120, even without the Egyptian production. If the Egyptian fields operate smoothly, the shares would be worth $140.

Hinton also likes

Redwood Trust

(RWT) - Get Report

, a real estate investment trust that yields 5.2%. The REIT invests in residential mortgages that are not backed by the government. Prices of mortgages sank during the financial crisis, and investors have remained concerned about potential defaults. Hinton says that the REIT managers have assembled a solid portfolio. "They are value investors who know how to spot very high-quality mortgages," he says.

Buffalo Flexible Income holds a mix that includes mainly dividend-paying stocks and high-yield bonds. During the past five years, the fund has returned 6.8% annually. Buffalo, which yields 3.0%, aims to deliver income as well as capital gains. "We want to provide a stable income vehicle that can be a core holding for conservative investors," says portfolio manager Paul Dlugosch.

Many portfolio holdings are rock-solid blue chips, including


(MSFT) - Get Report


Exxon Mobil

(XOM) - Get Report

. Lately Dlugosch has been shifting to master limited partnerships, which invest in energy infrastructure, and yield from 4% to 8%. A favorite holding is

EQT Midstream

(EQM) - Get Report

, which yields 4%.

At the time of publication the author held no positions in any of the stocks mentioned.

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This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of

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