The 5 Best Stock Funds for 2010

If there's a theme to the stock market recovery, it's that stocks of more speculative companies have soared.

Stocks of deeply indebted companies and small companies, particularly, have rebounded sharply since the market bottomed in March. But they had it coming. Many of these stocks had been pulverized during the bear market, so they’re mainly making up for lost ground. When you look at the year to date, the real winners emerge. Through December 15, funds that specialize in stocks of large, growing companies have been among the best performers, returning an average of 42%, according to Morningstar. For comparison, Standard & Poor's 500-stock index (which includes large value companies in addition to large growth companies) returned 26% and the small-company Russell 2000 index gained 23%.

Expect large growth stocks to excel again in 2010. What’s more, I think large growth stocks and the funds that invest in them will lead the pack whether the bull market continues or we fall into another bear market.

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The U.S. economy is still on the sick list, and the recovery is almost certain to remain anemic. In such a difficult environment, large companies with strong balance sheets and solid growth in revenues and earnings should be the top performers. Most of these companies reap an increasing percentage of their sales from selling in quickly growing emerging markets. Plus, most of these stocks are still surprisingly cheap given their attributes.

Don't neglect emerging-markets stocks next year either. The world really has changed. Developing nations, particularly China, are growing rapidly -- and many have far healthier balance sheets than either the U.S. government or its citizens. The MSCI Emerging Markets index has skyrocketed 76% so far this year. Emerging markets will surely hit potholes next year, but long term they are almost certain to continue growing at a fast clip.

Five funds to buy now

Large-company growth fund Vanguard Primecap Core closed to most investors earlier this year, so near-clone Primecap Odyssey Growth (symbol POGRX) is the best way to invest in the same strategy. I think it makes sense for 40% of your stock money. Many of the same managers that launched the original Vanguard Primecap fund in 1984 are still in charge here -- and their track record is terrific. Since its inception, Vanguard Primecap has returned an annualized 13.5% -- three percentage points per year better than the S&P 500.

Primecap Odyssey Growth currently owns big helpings of technology and health-care stocks. Top holdings include such high-quality companies as Amgen (AMGN), Eli Lilly (LLY) and Google (GOOG).

Fairholme (FAIRX) has committed few errors since its inception ten years ago. In every year except 2003, manager Bruce Berkowitz has beaten the average large-company fund that buys both growth and value companies. Since inception, the fund returned an annualized 13% while the S&P 500 returned a big, fat goose egg. Berkowitz recently loaded up on health-care stocks, which have been knocked down because of fears of health-care reform. He also holds 25% in cash and bonds. Trust this fund with 20% of your stock money.

Invest another 10% of your stock money in T. Rowe Price Small-Cap Value (PRSVX). The fund will shine if the market proves me wrong and pushes up prices of small-company stocks. Manager Preston Athey is a careful investor who favors steady-Eddy fare. And T. Rowe is a first-rate fund firm.

In fact, I'd put another 5% of your money into another T. Rowe fund, T. Rowe Price Emerging Markets Stock (PRMSX). After a disappointing 2008 (down 60.5%), the fund has jumped 84% so far this year. New manager Gonzalo Pangaro is doing a superb job, but the real credit goes to his large and experienced team.

For the main portion of your foreign-stock investments, I’d choose Masters' Select International (MSILX), which splits its assets among a half-dozen managers from different money-management firms. Mutual fund analysts Ken Gregory and Jeremy DeGroot hire and fire the subadvisers, and they’re good at what they do. Put 25% of your stock money here. The Masters' fund has roughly 25% of its assets in emerging markets, which will boost your total emerging-markets investments to more than 10% of your stock portfolio.

Steve Goldberg is an investment adviser.

Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.