(MONEY Magazine) – If you're a typical investor, your stock funds have probably returned 23% or so this year and doubled in value since January 1995. So you may be asking yourself: Don't those people at MONEY have anything better to do than carp about funds again?

We don't see ourselves as chronic complainers. For more than 25 years, MONEY has tried to be firm but fair with funds--praising them when they've performed well, criticizing them when they haven't. That tough-love approach is especially vital now. For the first time ever, stocks have risen an annual 20% or more for three years in a row. In the face of these historic gains, fund shortcomings that can nibble away a percentage point or so of your return may seem like mere trifles. But when stocks eventually stumble--and fund returns inevitably slide--that one percentage point will take a huge bite out of your gains. Moreover, if funds want to keep your trust during choppy markets as well as record runs, they will have to change how they invest--and the way they treat you. If they don't, you should replace the funds you own with new ones that consider you a true partner.

Below, ranked in order of their importance to shareholders, are what MONEY sees as funds' 10 biggest flaws, followed by our advice on what the funds--and you--should do to fix them.

1. FUNDS COST TOO MUCH.

As portfolios grow larger, fund sponsors can spread the cost of running them over a larger asset base. That means funds should be able to charge you lower expenses, raising your net returns.

But the opposite has happened: Back in 1987, according to Morningstar research analyst Jim Raker, the average diversified U.S. stock fund with at least $1 billion in assets charged 72[cents] a year for each $100 in assets. By 1996 (the latest year with full data), the tariff had grown by 3% to 74[cents], even as the average assets of those big funds ballooned by $2.6 billion, or 105%. An annual charge of 0.74% of assets--or even the 0.96% charged by the typical U.S. stock fund--may not seem like a big deal. But after inflation and taxes, the typical investor will be lucky to earn a 4% annual long-term return on stocks. So when fund managers grab 0.96% a year, they are keeping nearly a quarter of your expected return.

Still, fund companies keep hiking their expenses. Ralph Wanger, manager of the Acorn Fund, declared in MONEY's February 1997 issue: "Unless fees come down, investors will get tired of being hosed, and they will find another way to invest." But then, last October, Wanger asked his shareholders to approve a 53% increase in Acorn's fees.

"I could not believe that," sputters Mark Liebman, an investor in Manhattan who has owned Acorn since 1994. "He tells MONEY everyone else's fees are too high, then raises his own. The customers really seem to be at the bottom of the pile." Wanger responds that his small firm needs more revenue if it is to service 401(k) plans and hang on to its talented young analysts and portfolio managers. He also adds that Acorn's new expense level of 0.87% is among the lowest for funds of its type and well below the 1.41% average for domestic stock funds.

What funds should do: Stop raising funds' annual expenses, and start cutting them.

What you should do: Refuse to buy any fund with above-average expenses. (You can check a fund's expenses in the tables beginning on page 58 or in Morningstar Mutual Funds.) Vote your proxy against any fee hike your fund proposes. If the fees go up anyway, consider selling your shares.

2. FUNDS ARE TOO BIG FOR YOUR OWN GOOD.

When a portfolio grows like a mutated mushroom, fund sponsors reap higher management fees. Rampant growth in assets may be bad for you, though, because returns may suffer. In a recent speech, Vanguard Funds chairman John Bogle looked at today's five largest actively managed stock funds with 20-year histories and found they had beaten Standard & Poor's 500-stock index by 10 percentage points annually from 1978 through 1980--when they were small ($517 million on average). But after the portfolios bulked up to a paunchy $23 billion on average, they lagged the S&P 500 by three points annually from 1994 through 1996. His conclusion: "Funds that have created a record of remarkable returns at relatively small asset levels have a pronounced tendency to lose that edge when they get large."

Fast-growing funds specializing in smaller stocks have an especially tough time sustaining superior performance. Since managers can't find enough small-fry shares to plow new money into, they resort to buying bigger stocks. In 1990, for example, PBHG Growth Fund had $12 million invested in stocks with an average market value of only $283 million. From 1991 through 1995, it returned a stunning annual average of 35.1% vs. 16.6% for the S&P 500. But as PBHG Growth swelled to more than $5 billion in assets, manager Gary Pilgrim began buying more stocks (107 today vs. 74 in 1990) with a larger average market value ($1.4 billion vs. $283 million)--and the fund lagged the market by a shocking 55 percentage points over the two years to Dec. 1. Pilgrim responds that the average size of the fund's stocks has climbed in part because the bull market has driven up market capitalizations overall. He also contends that the fund has trailed the market recently--as it has from time to time in the past--largely because its strategy of buying rapidly growing companies has fallen out of favor. "If you are linking performance to our asset size," says Pilgrim, "you are barking up the wrong tree."

What funds should do: Sponsors should close their small-stock portfolios to new investors when they surpass $1 billion or so in assets.

What you should do: Invest with firms that have a history of closing funds--such as T. Rowe Price and Longleaf Partners--or that announce they will stop taking new money once a fund hits a certain size, as Wasatch and N/I recently did. (For a closer look at the N/I funds, see the story on page 36.)

3. FUNDS ARE TOO TAXING.

Here's a fact that should give you the screaming meemies: In a 1995 paper, Stanford economist John Shoven and Ph.D. student Joel Dickson estimated that the Internal Revenue Service skimmed off nearly two percentage points a year from the typical fund investor's return from 1962 to 1992, shrinking a 10.8% average annual gain to 8.9%. True, your fund can't repeal Uncle Sam's tax laws. But Dickson, now an analyst at the Vanguard funds, figures that if managers tried harder to limit the taxable gains that funds distribute each year, shareholders could pay 50% less in taxes.

Sadly, most managers devote little, if any, attention to how taxes shave investors' gains. In 1996, for example, 684, or 34%, of the 2,030 diversified U.S. stock funds paid out at least 10% of their value to shareholders in dividends and capital gains. Result: If you were in the 28% tax bracket and invested $10,000 at the beginning of that year, you would have had to fork over roughly $300 to the IRS, even if you hadn't sold a farthing of your fundholdings.

What funds should do: Disclose their tax efficiency, which shows the percentage of a fund's gains an investor in the 28% bracket would have kept after taxes. The tables in this issue provide this figure.

What you should do: Put funds that generate high tax bills into tax-advantaged accounts like a 401(k) or Individual Retirement Account. For taxable money, consider tax-efficient funds like Vanguard's trio of tax-managed portfolios or Standish Tax-Sensitive Equity, which actively try to minimize taxable gains.

4. MANAGERS ARE TRIGGER-HAPPY.

Managers talk a lot about investing for the long term, but many of them have the attention span of a grasshopper. With an annual portfolio turnover rate of 87%, the typical equity fund holds its stocks for a mere 14 months.

But the faster managers run, the behinder they get. A recent Morningstar study found that funds that owned their typical stock for at least five years earned an annual average of 12.9% for the 10 years to July 1, while funds that held stocks for less than one year earned just 11.3% on average.

One reason that trigger-happy managers often lag their laid-back peers is that every time a fund buys or sells a stock, its trading costs diminish profits. According to the Plexus Group, a Los Angeles consulting company, a fund with a typical 87% turnover rate could rack up 1.7% in annual trading costs, enough to trim a 10% return down to just 8.3%.

What funds should do: Practice what they preach about investing for the long term.

What you should do: Favor funds that hold their stocks for at least five years--shown by a turnover ratio of 20% or less--including such stalwarts as Dodge & Cox Stock, Investment Company of America and Vanguard Index 500.

5. MANAGERS MOVE AROUND TOO MUCH.

These days, star fund managers jump ship more quickly than the starting lineup of the Florida Marlins. Look at Kemper Growth. In the spring of 1996, it hired away Founders Growth's manager, Patrick Adams, to replace Steven Reynolds, who had been at the fund's helm for just one year. Then, just eight months later, Adams returned to Denver to run Berger 100, and Reynolds took over at Kemper Growth again. Since the end of 1993, Kemper Growth has had four management changes--and, not coincidentally in my opinion, has lagged the S&P 500 by nine percentage points annually. Worse, it has bombarded investors with big taxable capital gains, thanks in part to the incessant housecleaning as each new manager swept away some of the last manager's stocks.

What funds should do: Managers would stay put longer if they thought of themselves less as hired hands and more as owners whose interests are aligned with yours. Several fund companies, including Longleaf Partners, encourage that financial kinship between managers and shareholders by requiring managers to invest their bonuses in their own funds.

What you should do: Never buy a fund just because it has a high-profile manager. Instead, look for portfolios with consistently below-average expenses and low turnover in both stocks and managers.

6. TOO MANY MANAGERS ACT LIKE SHEEP.

One reason only 25% or so of funds beat the market averages over long periods of time is that most managers invest with a herd mentality. Recent research by finance professors Josef Lakonishok, Andrei Shleifer and Robert Vishny found that money managers place the bulk of their assets in stocks with only middling potential for risk and return rather than in those with higher odds of gain or loss. Such a cautious strategy reduces the odds that managers will strike out--and suffer the embarrassment of drastically underperforming their peers. But that timid stance also makes it virtually impossible for managers to hit home runs.

As legendary stock picker Warren Buffett has preached for decades, the best way for an investor to excel is to go against the grain by buying a small number of intensely researched stocks--and then holding them for a very long time. To get superior returns, a fund manager must either own superior stocks that others don't, place big bets on his favorites--or both.

What funds should do: Dare to be different rather than merely mirror the market.

What you should do: Think twice before buying a fund that owns more than 100 stocks. If the manager lacks the conviction to concentrate your money into his best ideas, you're better off in an index fund.

7. FUND DIRECTORS LACK BACKBONE.

Your fund's board of directors is supposed to work for you, not for the fund sponsor. But too often directors simply rubber-stamp the management's agenda.

Over lunch recently, one fund manager--who understandably wants to remain anonymous--told me a troubling story about a board meeting at his former company. "An independent director said to me, 'You should stop focusing on long-term returns--don't you know that short-term performance is the name of the game for gathering assets these days?' I couldn't believe my ears! I said, 'You mean short-term, like monthly returns?' He said, 'That's right.' And that's why I left to work at another firm."

I'm sure there are many directors who work hard to ensure that your fund is run in your best interests. But many others, like the shortsighted guy above, believe that part of their role is to help the fund's sponsor "gather assets" and rake in more fees. If fund directors always had your interests at heart, virtually every problem in this article would disappear. At their worst, directors allow managers already making profit margins as fat as 40% to ask for even higher fees; they permit small-stock funds to grow too large for their own good; and, in several cases, they have poorly supervised the way the manager valued securities, contributing to sudden losses.

What funds should do: Stop appointing executives who formerly worked for the fund sponsor as "independent" directors of that group's funds. Print directors' names and business addresses prominently in the prospectus, so shareholders can write to them with complaints and suggestions.

What you should do: If your fund's proxy contains any proposal you don't like, vote against the directors to show them you're watching.

8. FUNDS REPORT IN GIBBERISH.

Flip through a pile of prospectuses, and you're likely to come across hundreds of sentences like this 77-word jawbreaker from the November 1997 prospectus for Guinness Flight Mainland China Fund: "Since it can be expected that a call option will be exercised if the market value of the underlying security increases to a level greater than the exercise price, this strategy will generally be used when Guinness Flight believes that the call premium received by the fund plus anticipated appreciation in the price of the underlying security up to the exercise price of the call will be greater than the appreciation in the price of the security."

Now here's my 20-word translation: "We will use call options when we think we can make more money on them than on a stock alone." My version probably wouldn't pass muster with the lawyers who are paid to protect funds from lawsuits, but it would be a lot clearer.

When it comes to topics you might actually understand and want to factor into your investing decision, however, the normally prolix prospectus writers clam up. Would you like to know how the portfolio fared during the last bear market, or whether the fund is more suitable for taxable or for tax-deferred accounts, or how much money, if any, the fund manager and directors have invested in the fund? Sorry, the prospectus is silent on these important issues.

What funds should do: Rethink not just how the prospectus is worded--as the SEC's "plain English" initiative urges--but what's in it. Investors deserve information that can help them decide how closely the financial interests of the fund's managers and directors are aligned with their own.

What you should do: If you can't find what you're looking for in a prospectus, ask the fund company for answers. If the company won't provide the information you want, don't buy the fund.

9. THERE ARE TOO MANY FUNDS.

From the beginning of 1995 through last October, fund companies hatched 933 portfolios, or about one a day--okay for vitamins, but a big overdose for fund investors. Says John Markese, president of the American Association of Individual Investors: "Too many of the funds that are coming out are being created for marketing reasons rather than what's good for the investing public."

Should fund investors really be directing their money to narrowly focused theme-based portfolios like the Gabelli Global Interactive Couch Potato Fund, which hopes to profit as people from Albania to Zimbabwe turn into Web surfers and cable-TV addicts? Or the Pauze Tombstone Fund, an index fund that invests in undertakers, coffinmakers and cemetery operators? It's flashy concepts, not terrific investment ideas, that motivate many fund launches these days--all in an attempt to stand out in an overcrowded field.

What funds should do: Stop introducing marketing concepts disguised as funds.

What you should do: Don't be swayed by gimmicks and gewgaws; stick to a few of funds that excel at fundamental strategies like investing in top-performing growth shares or scooping up undervalued stocks.

10. FUNDS ARE GETTING TOO COMPLICATED.

"The fund industry has taken the inherent simplicity of mutual funds and trashed it," says Morningstar president Don Phillips. A decade ago, you paid a front-end sales load, a back-end load, or you bought a no-load fund. Now your broker or financial planner offers more choices than a warehouse full of Chinese menus. There are countless "share classes," each with its own fee structure. Among them: Classes 1, 2, 3 and 4; Classes A, A-I, A-II, B, BL, C through K, M through T, X, Y and Z. Then there's Common Class, Consultant Class, Consumer Service Class and scads more. "All this," says Phillips, "focuses your attention on the cost, rather than the benefit, of the advice a good financial adviser can provide."

What funds should do: Subject executives and brokers--now exempt from sales charges--to the same cockamamie fee choices other investors face. Fund companies should stop opposing repeal of the federal law that requires sponsors to set fixed sales loads, so investors and financial advisers can negotiate lower fees.

What you should do: Tell your financial adviser you're a long-term investor and ask him to demonstrate which fund class has the lowest cost over periods of 10 years or more--or you can just stick to no-load funds.