(MONEY Magazine) – The Dow has been turning out records faster than RCA this year. Indeed, it has crossed five century marks and set 33 all-time highs in little over three months. Its first-quarter rise of 21.4% was the greatest three-month gain in a dozen years. For individual investors, stock mutual funds have been one of the best ways to go along for the ride. Even as small investors have pulled out of individual stocks, equity fund sales have surged -- to $13 billion in the first two months of 1987, more than the total annual sales for stock and bond funds in any year prior to 1982. And though very few funds have outpaced the bull in each of the past five years (see the ''Index Beaters'' table on page 38), returns have generally been gratifying: the average equity fund has gained 192.6% since the uptrend began in August 1982. Some funds, of course, have done better. The trick is finding them. Three years ago the trick would have produced a treat if you had bought the diversified stock funds that make up Money's Top 40 (see page 40). The least of them would have more than doubled your money. The top performer, Pacific Horizons Aggressive Growth, would have turned a $10,000 investment into $30,800 in the three years through March. (You can find phone numbers for funds mentioned in this article on the Top 40 table or in the alphabetical listings beginning on page 190.) But for investors pondering mutual funds right now, there is little to gain by replaying old hits. The question is: Will these funds repeat for the next three years? The answer depends on how long the stock market maintains its recent infatuation with hotshot growth stocks -- that is, companies with prospects for rapid profit increases. In the past couple of years, Wall Street had eyes mainly for stodgy, high-dividend blue chips, financial companies and utilities -- the choices in a market dominated by falling interest rates and a plodding economy. For mutual funds, the result was that the conservative entries that invest in these stocks -- such as utility sector, diversified growth and income and balanced funds -- roared ahead while the more daring growth funds languished, just the opposite of what you would expect in a five-year-old bull market. Historically, because investors are more willing to take risks when stocks have been rising for a while, growth-hungry funds have led the pack when a bull grew long in the tooth. Over the three years through December, though, the top-scoring diversified stock funds -- with a 63.7% average return -- were the balanced funds, which aim for a conservative mix of stocks and bonds. At the bottom were small-company growth funds with only a 22.3% gain.

The first three months of 1987 changed all that. The prospect of a revitalized U.S. economy focused investors' attention on corporate earnings, and for the first time since 1983 the market began to bid up the prices of growth stocks. Among diversified stock funds, the new emphasis on growth catapulted a number of single-minded growth-getters into Money's Top 40 for the three years through March. In addition to Pacific Horizons, they include ABT Emerging Growth (up 33.4% for the quarter), Constellation Growth (up 36.1%) and Twentieth Century Vista (up 41%). The undisputed Elvis of this hit parade, however, is our cover subject, G. Kenneth Heebner, 46, of Boston's Loomis-Sayles & Co. Heebner, a workaholic with a 60-hour, six-day-a-week habit, runs five funds, four of which cracked Money's Top 40. His No. 2-ranked Loomis-Sayles Capital Development, a high- risk, high-return no-load growth fund with $300 million in assets, was up 160.7% for the three years through March. One of only five entries to be ranked among the Top 20 mutual funds by Lipper Analytical Services in each of the 15-year, 10-year and five-year periods through March 1987, Capital Development is currently closed to new investors.* But Heebner's other three Top 40 funds are still open. They are No. 14 Loomis-Sayles Mutual, a no-load balanced fund, up 119.3%, and two load funds sponsored by Loomis-Sayles' parent company, New England Life: No. 13 New England Growth (up 122.1%) and No. 19, New England Retirement Equity (up 117.4%). Heebner's fifth fund is Zenith Capital Growth, a tiny ($13 million in assets) aggressive growth fund that Money does not track because it is sold only as part of a New England Life variable life insurance policy. Had Zenith qualified for our list, it would have topped it by a stunning margin: the fund has returned 226% in the past three years. For Heebner, taking risks is an essential part of the stock-picking game. He looks for companies with the potential for a spurt in earnings large enough, and unexpected enough, to propel the stock ahead 50 percentage points faster than the market average. ''It's a pretty ambitious goal, I know,'' he says. ''In an average year, only 20% of my picks will meet my objective.'' Late in 1986 he staked 25% of Capital Development's portfolio on technology stocks, including Digital Equipment, Seagate Technology and Lotus Development. All outperformed the market in the first quarter, and Seagate did so by a goal- busting 60 percentage points. Result: Capital Development was up 37.5% in the first quarter of 1987. But Heebner's ability in bull markets has a flip side: his duds tend to turn tail when stocks turn grizzly. Capital Development, for example, took a 28.2% loss in the June 1983 to July 1984 market slump -- 13 percentage points worse than the market's 15% slide. ''If there's a correction for a couple of days, my funds are always going to do worse than the next guy's,'' he admits. ''That happens when you have stocks with big gains: the first thing people do is take profits and sell those stocks.'' Only Heebner's Loomis-Sayles Mutual, which he keeps 20% to 50% in bonds, bucks the family trend. In the past its fixed- income cushion made it less subject to the jitters than Heebner's other funds. Many of the other Top 40 performers are also heavy bleeders in bear markets. And at this stage of the game, that is probably a good reason to avoid them. According to many fund analysts and portfolio managers, the probabilities strongly favor a 10% to 25% skid in stock prices within the next two years. After all, they point out, the market has been upbeat since the summer of 1984. And compared with almost any standard for valuing stocks -- prices vs. corporate earnings, net worth or dividends -- share prices are as high, or higher, than they have been since the eves of the painful market setbacks in 1972, 1968 and 1961, when shares fell by a minimum of 28%. True, stocks may continue to reach even higher prices, concedes Walter Rouleau, editor of the mutual fund newsletter Growth Fund Guide (Box 6600, Rapid City, S.D. 57709; $85 a year). But each new record makes him increasingly nervous. ''It's like walking on a frozen pond,'' he says. ''The farther out you go, the thinner the ice and the farther you sink if it gives way.'' Matthew Weatherbie, portfolio manager of $130 million Putnam OTC Emerging Growth (6.75% load; up 129.7% in the past three years), is more blunt: ''I think a serious correction is inevitable this year.'' If that happens, look for many of this year's Top 40 in next year's remainder racks. If the market truly is so chancy, should you get into stock funds at all? If you are very shy of risks, probably not. Donald Yacktman, manager of Selected American Shares, a low-risk growth and income fund that placed 36th in the Top 40 and second on our list of Top Defenders (page 38), advises wary investors first to consider whether they could better deploy their cash elsewhere. You can get a respectable and certainly more assured return, he points out, by refinancing a high-rate mortgage (11% or greater), for example, or paying off credit-card debt. Another alternative is to park your money in a money-market fund and wait for any stock market correction to run its course. The problem, though, is that you may find yourself passing up opportunities in the meantime. Take the case of Bernard Klawans, manager of the Valley Forge Fund (which is too small to be ranked by Money). Anticipating a downturn that never came, he has been 80% in cash since early 1986 -- and thus has watched a 43% gain in the market pass him by. ''You can never know whether the correction is around the corner or the market is going a lot higher first,'' cautions Gerald Perritt, editor of the Mutual Fund Letter (205 W. Wacker Dr., Chicago, Ill. 60606; $95 a year). ''That's why a smart investor doesn't take an all-or-nothing approach to stock funds.'' Like many investment advisers, therefore, Perritt recommends that investors , get into funds even at their current lofty levels. The trick is to do it cautiously. These strategies should help: Favor stock funds that will hold up well if the market turns. Most fund analysts are convinced that the top mutual funds for the next three years will be those that emerge from a correction in good shape. Accordingly, they recommend you stick to funds with a record of protecting share value in down markets, such as the Top Defenders on page 38. Generally, these funds fall into two categories: income-oriented and value- oriented. Funds in the first category, such as Evergreen Total Return, Vanguard Wellesley Income and Vanguard Wellington, invest for yield by buying high-dividend stocks, convertible bonds and some conventional bonds. The income-producing securities are generally more stably priced than growth stocks and so provide a kind of safety net in a falling market. Value-oriented funds such as Mutual Shares, Selected American Shares and Neuberger & Berman Partners invest in out-of-favor stocks with comparatively low prices. Thus when investor sentiment turns against stocks in general, such securities do not have as far to fall as stock market darlings. Gerald Perritt thinks that small-company growth funds may be another place to hide during a chill phase in the near future. Ordinarily, frisky small- company stocks take a beating in a market sell-off. For most of this blue- chip bull market, however, small-company shares have substantially trailed those of larger outfits. Bucking conventional wisdom, Perritt thus believes that small-company funds would fall less and bounce back higher than funds that invest in more established stocks. Perritt's picks among small-company specialists: Babson Enterprise (no load; up 14.8% in the past year) and GIT Trust-Special Growth (no load; up 11.1%). Plan for a pause in the bull market for bonds as well. As with stock funds, it probably will not pay to bet on a continuation of bond funds' rosy recent past. Bond funds that prospered most during the past three years -- such as Axe-Houghton Income (up 81.8%) and E.F. Hutton Bond & Income Series (up 76.6%) -- generally did so by concentrating on bonds with maturities of more than 20 years. Then as long-term Treasury yields fell from roughly 14% in 1984 to 7.5% now, share prices took off. (Because they tie up your capital longer, long- term bonds appreciate more than short-term bonds when rates decline -- and fall faster when rates rise.) Bond market watchers are calling for a more ! sedate performance this year. Says E.F. Hutton portfolio manager George Mueller Jr.: ''We're looking for a replay of the bond markets of the '50s, when interest rates were stable and your total return was the same as your yield.'' Mark Dollard, senior portfolio strategist for the pension management firm Amivest in New York City, thinks Ginnie Mae funds such as Vanguard GNMA will thrive in that kind of environment. If interest rates remain flat, he points out, Ginnie Mae returns should be higher than those on Government or high- grade corporate bond funds because of their current yield advantage of half a percentage point or more. And if interest rates rise, the Ginnies' short effective maturities should help them hold their value more securely than government or corporate bond funds with comparable yields. But the surprise heroes of 1987 may be -- you won't believe it -- junk bond funds. So says Norman Fosback, editor of the newsletters Mutual Fund Forecaster (3471 N. Federal Hwy., Fort Lauderdale, Fla. 33306; $49 a year) and Income and Safety (same address and price). If the economy picks up this year, says Fosback, a participant in Money's mutual funds roundtable (page 42), it could lead to higher interest rates. Reason: the Federal Reserve Board, possibly fearing an overheated economy and the resurgence of inflation, might choose to tighten the money supply. One result would be lower prices for funds invested in long-term Treasury or high-grade corporate bond funds. But the yields of junk bond funds -- recently about three percentage points higher than those on government or high-grade corporate bond funds -- provide a kind of cushion against rising rates. Moreover, in an improving economy, investors are likely to judge junk bond issuers as better able to handle their high interest payments, which could buoy prices further. Of course junk bond funds have their own risks. If the hoped-for expansion fails to materialize and if issuers default on their bonds in any great numbers, the funds will take a beating. To minimize the potential risk, advises Fosback, favor junk bond funds with at least 80 different issues or buy shares in at least two funds; then, if one or two bonds get into trouble, your damage will be limited. His picks: Pilgrim High Yield (1.5% load) and the no-load Bull & Bear High Yield. Ease into your fund. ''This is not the time to make a big initial investment in any fund,'' says Michael Lipper of Lipper Analytical Securities Corp., a mutual fund reseach firm. Instead of putting all your money into the market at once, Lipper advises, spread the investment out in even installments over several months. This technique, called dollar-cost averaging, protects you from jumping in with both feet just before the bottom falls out. Diversify. Since it is impossible to foresee which portfolio manager will have the hot hand in the years ahead, your best course is to put your money into several hands. Michael Hirsch, chief investment officer of Republic National Bank in New York City, suggests you diversify by management style as well as by manager. You might, for example, divide the equity portion of your fund portfolio among value-oriented, income-oriented and small-company funds. The proportion allotted each would depend on whether your investment goals tilt toward growth (in which case you would weight the small-company fund more heavily), or safety (in which case you would lean toward the income fund). Keep fees to a minimum. In any market, sales loads and marketing fees cut into return (see the worksheet on page 37). For example, your actual three- year return from Putnam Voyager, No. 12 in Money's Top 40, would have been 105.7% rather than the 124.8% earned by the portfolio, because you would have had a hefty 8 1/2% sales load deducted from your investment up front. In a touchy market like this one, it pays even more than usual to minimize loads, both front end and back end. In case of a downturn, you may find yourself pulling out of the fund soon after you invested, before time and appreciation have had a chance to erase the effect of the load. Consider taking profits on funds you already own. If you hold shares in a fund -- particularly a relatively risky one that has appreciated substantially since you bought it -- think about switching out to a safer money-market or bond fund. As with getting in, the prudent way to get out is a portion at a time. You might begin by lowering your holding by 25% immediately, and then withdraw another 25% each time the fund advances 10%. This lets you keep part of your money at work in the market without exposing your whole investment to a bear. At the same time, it spares you the exquisite frustration of bailing out only to see the market take off without you.

FOOTNOTE: *The other funds are Fidelity Magellan, Quasar Associates, Twentieth Century Select and Weingarten Equity.

BOX: At last, a way to compare loads and fees

In the days when loads were loads and no-loads were no-loads, a mutual fund investor knew where he stood. If you wanted a broker's advice in selecting a fund, you paid for it up front in the form of an 8.5% sales load. If you didn't, you bought no-load fund shares by mail. Nothing is so simple anymore. Nowadays, you must contend with a thicket of new charges that make it difficult to figure out the real cost of investing in a fund. The worksheet and tables below, devised for Money by John Markese, research director for the American Association of Individual Investors, will enable you to compare all fees, including front-end loads, back-end loads or exit fees, if any, and annual expenses. (Annual expenses, usually lumped together and expressed as a percentage of the fund's total assets under ''per share data'' in the fund's prospectus, include management fees and so-called 12b-1 charges.) The key to making the conversions work is to estimate how long you will own shares in any fund you are considering. The table at left (below) then converts front-end loads into the equivalent of fixed annual expenses. The table at right performs the same translation for back-end loads, assuming the fund grows at a 10% annually compounded rate. The worksheet makes it easy to come up with a total figure for annual expenses, expressed as a percentage of your investment. Here's how the calculations work. Suppose you expect to hold a fund's shares for three years and want to compare the costs over that period for two funds -- for example, Fidelity OTC, with a 3% front-end load and total annual expenses of 1.5%, and broker-sold Hutton Special Equities, which carries no front-end load but has total annual expenses of 2.2% and a back-end load. The charge is 5% on shares you redeem in the first year you own the fund; it declines by a percentage point each year thereafter. By consulting the appropriate table, you discover that OTC's 3% front-end load is equivalent to a 1% annual charge over three years (read across the row for years held -- in this case three -- until you reach its intersection with the column for a 3% front-end load). Using the worksheet, add the front-end load equivalent (line A) to the fund's 1.5% annual expense charge (line C); line B can be left blank. Total equivalent annual expense: 2.5%. By reviewing the table at right in the manner described above, you find that Special Equities' back-end load (3% after three years) is equivalent to an annual charge of .75% over three years. Add that figure (line B) to the fund's annual expenses of 2.2% (line C) and you get an equivalent annual expense of 2.95%. The conclusion: the Hutton fund is the higher cost fund over three years. Thus, unless you believe the assistance of a Hutton broker is worth the extra cost, or unless you expect the Hutton fund to outperform the Fidelity fund by at least 0.45% per year over the next three years, OTC is the better bet.

BOX: Figuring your fund's true costs

A. Annual equivalent expense for your fund's front-end load, if any (from table 1) ------------ B. Annual equivalent expense for your fund's back-end load, if any (from table 2) ------------ C. Your fund's annual expenses (from fund prospectus)