(MONEY Magazine) – For mutual fund shareholders, 1988 started two months early -- on Oct. 19, 1987, the day the bulls ran into a brick wall. Since that day, the dominant mood of fund investors has been gloom, and not even a spirited 15.1% rebound by stock funds last year could shake them out of it. While that gain fell short of the 16.6% growth in Standard & Poor's 500-stock index with dividends reinvested -- the sixth year in a row that the average stock fund failed to beat its theoretical benchmark -- fund investors had little cause for disappointment. Ten of MONEY's 11 equity categories posted double-digit returns, led by small-company growth funds, up 18%. The lone laggard: gold funds, off 16%. The six categories of taxable fixed-income funds rose 8.6% on average. But that was not enough to erase the sense of foreboding left by the crash. ''People are still depressed,'' says Kurt Brouwer, president of the San Francisco investment advisory firm Brouwer & Janachowski. ''They are convinced that we are in a bear market, and they don't want to be distracted by good news.'' Indeed, for the first time in five years, investors put less money into funds than they pulled out. The negative cash flow, disregarding reinvested dividends, was $13 billion through November. Not surprisingly, sales stalled for all varieties of stock funds, except for the conservative equity income funds, which showed a net gain of $385 million. Bond funds fared generally better, but not across the board. After pouring $90.5 billion into government bond and Ginnie Mae funds during 1985 and 1986, investors withdrew $10.5 billion more than they put in last year. A. Michael Lipper of Lipper Analytical Services, which supplies the data for the fund rankings that begin on page 53, speculates that many of the redemptions were instigated by brokers seeking to move their clients into last year's high-sales-commission lure, initial public offerings of closed-end bond funds. But much more of the money probably went back into money markets and risk-free bank alternatives. ''A lot of investors discovered that you can lose money in government-guarantee d bond funds, and they wanted out,'' says Lipper. Still, most investors who stuck by their funds last year bagged substantial rewards. For example, the top performer in MONEY's data base of 863 large ($25 million or more), widely available funds, Integrated Equity-Aggressive Growth, rode last winter's surge in small-company stocks to a 48.5% gain. Neil Eigen, manager of the fund's $26.5 million portfolio, argues that the rally was inevitable: after four years of lagging the market, the fast-growing small companies were simply too cheap to be ignored. And though small stocks have drifted since last spring, Eigen believes that they are only taking a breather. ''These stocks have a long way to go before they're overvalued,'' he says. Last year's second-ranked fund, $31 million Columbia Special, which rose 41.2%, likewise got a kick from small- to medium-size-company stocks, which make up about 50% of the portfolio. But manager Alan Folkman also successfully ; played the other great investment theme of 1988: buy-outs like retailer Federated, which was acquired by Campeau Corp. Investing in international stock funds proved profitable, though not the romp it had been in recent years. In 1988, internationals posted an increase of 17%, the second best return of MONEY's fund categories. The group was led by $135 million Alliance International, which rose 32.7%. A climbing dollar hampered the internationals' returns through the summer. But by the end of the year, the buck fell back, allowing U.S. investors to benefit from the performance of foreign markets, most of which outperformed the S&P 500. With many analysts predicting further declines for the dollar, international funds might have a leg up on 1989 as well -- although if the Alpine-priced Tokyo stock market cracks, all bets are off. The major turnaround of '88 -- from first to last -- came in the highly volatile gold category. But several historically dependable growth funds finished surprisingly far back in the pack. Among them were such favorites as Loomis-Sayles Capital Development (down 0.3% for the year), Phoenix Growth (up 7%) and 20th Century Growth (up 2.7%). All three funds invest in established companies with strong earnings prospects, a strategy that usually produces solid gains in rising markets. But last year's market, riven with recession angst, had no faith in the ability of growth companies to continue increasing profits. ''We owned stocks with some of the most favorable combinations of high growth rates and low price/earnings multiples we've ever seen,'' complains Robert Puff, co-manager of 20th Century's equity funds. ''But most of the action was in 'deal' stocks.'' Among fixed-income funds, the best-performing category was high-yield corporate (or junk) bond funds, which returned 11.9%. Yield-hungry investors apparently could not resist the temptation, rewarding junk funds as a group with a net cash inflow of $2.3 billion. That was second only to tax-exempts (up $4.5 billion) -- despite analysts' warnings that many financially weak junk issuers could default in an economic downturn. Ironically, funds that suffered most from credit worries were those invested in high-grade corporates. When fiscally solid firms like RJR Nabisco and Philip Morris announced plans to take on vast new debt to pay for buy-outs or acquisitions, their once high-rated bonds began trading at junky yields, causing price declines of up to 10%. The top high-grade corporate fund, $222 million American Capital Corporate Bond, pulled out a 12.9% return, against an 8.2% category average. Portfolio manager David Troth attributes his success largely to his fortuitous avoidance of credit downgradings. ''We were overweighted in safe sectors, like utilities, and underweighted in retailers, where a lot of the action occurred,'' he says. ''I wish I could say it was all skill, but we were lucky.'' Going abroad for income was even more popular with investors than it had been the previous year. In 1988, investors bought $1.2 billion worth of new shares in one of 1987's top categories, global income funds, which invest in U.S. and foreign fixed-income securities. But compared with 1987, when the falling dollar boosted several funds' returns beyond 20%, the global income payoff was disappointing. With rising interest rates abroad -- and no help from a generally stable dollar -- the funds produced a modest gain of around 7%. (MONEY monitors this small group in the global category, along with global equity funds.) T. Rowe Price International Bond, the best of the global bond funds in 1987 (27.6% return), actually lost 1.3% in 1988. Beginning this month, Fund Watch separates out a category called flexible income to track the growing number of funds in which the portfolio manager has wide latitude in choosing the most promising income approach. Some borrow to buy more bonds for the portfolio, as does Northeast Investors Trust (up 14.1%); others gauge market conditions and swing between long-term and short- term bonds, as does Strong Income (up 12.5%). Last year's top flexible performer, National Total Income, up 18.1%, normally splits its $142 million portfolio between bonds and dividend-paying stocks. You will find the leading flexible fliers along with other star-performing funds of 1988 on the following pages. The funds are ranked within each category by their percent gain (or loss) to Jan. 1. Since funds are designed primarily to be long-term investments, also be sure to note their return over three, five and 10 years. To give you a basis of comparison on long-term performance, the funds are ranked high, middle or low within their category on the basis of five-year returns. A grade of high means the fund placed in the top 20% of its category from 1984 through 1988. Middle places the fund in the next 60%; low denotes the bottom fifth. The five-year expense projections are taken from data that the Securities and Exchange Commission requires each fund to place in its prospectus. The projections allow you to compare the total costs you would pay on a $1,000 investment -- including management fees and operating expenses, as well as any sales loads, redemption charges or 12b-1 fees -- assuming the fund grew at 5% a year and you redeem your shares at the end of five years. These expenses detract directly from your investment; so, all else being equal, a fund with lower total costs has a head start for 1989. And judging from investors' -- and many analysts' -- glum reaction to 1988, funds may need all the help they can get. ''I think last year was a rally in a bear market,'' says Walter Rouleau, publisher of Growth Fund Guide (P.O. Box 6600, Rapid City, S.D. 57709; $85 a year). ''The stock market is still overvalued, and we've stretched out the economic expansion about as far as it can go. I think 1989 is a year to be very careful.'' But that doesn't mean you should forget a key lesson of 1988: that stock funds deserve a place in the portfolio of virtually every long-term investor.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: At a Glance How they finished Investors who didn't cower on the sidelines in '88 waiting for the other shoe to drop got solid returns and a reminder that a hot category one year can suddenly cool.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: TOP-PERFORMING STOCK FUNDS; TOP-PERFORMING BOND FUNDS; BEST- PERFORMING MONEY MARKET FUNDS.