(MONEY Magazine) – Over the full sweep of time, mutual funds have shown that they are probably the greatest contribution to financial democracy ever devised.

But like every democratic structure, they are far from perfect.

Failing to beat the market, as 90% of all funds have done for the past four years running, is a longstanding pattern (see the chart below).

When regulators leave the least loophole, fund companies will pile through it--and investors will end up sorry (see the events of 1954, 1967, 1986, at right).

And if a fund idea is trendy, it's probably bad for you (see 1929, 1968, 1983, 1991).

'20s

HOT: closed-end funds NOT: closed-end funds

1924: Edward G. Leffler invents the world's first open-end fund, Massachusetts Investors Trust. The day the fund is founded, March 21, the Dow closes at 95.87. After one year, MIT has 200 shareholders and $392,000 in assets.

1924: The entire fund industry, consisting of a few closed-end funds, has less than $10 million in assets.

Paul Cabot co-founds State Street Investment Trust, the second open-end fund, four months after MIT. These two funds are the first ever to allow investors to sell their shares back to the fund company at any time.

1925: Edgar Lawrence Smith founds Investment Trust Fund A, which invests according to the precepts of his book, Common Stocks as Long Term Investments, the first major work to argue that stocks will outperform bonds and cash over time.

1927: Closed-end funds (then called investment trusts) spring to life on Wall Street. From March to August alone, they multiply from 49 trusts with $350 million in assets to 97 trusts holding $750 million.

1928: Boston money manager Scudder Stevens & Clark creates the first no-load fund, First Investment Counsel Corp. (now Scudder Income Fund).

1929: Investors bid up closed-end shares to absurd levels, shooting total assets past $3 billion. Sales charges of 10% are common, expenses run up to 12.5% and many funds refuse to disclose their holdings. On Oct. 29, "Black Tuesday," the Dow crashes, dropping 12%. By year-end the index is at 248.48, off 17%, and the Great Depression has set in.

FUNDS 21

ASSETS 134 MILLION

AS OF 12/31/29

'30s

HOT: government crackdowns NOT: stock funds

1931: Edgar Lawrence Smith's Investment Trust Fund has lost an estimated 75% of its value since its 1925 launch.

1931: Jonathan B. Lovelace founds Capital Research & Management, parent of the Ameri-can Funds, today's third largest fund family.

1932: Merrill Griswold, chairman of MIT, founds the fund industry's first research department to ensure that an analyst studies every stock before the fund buys it.

The Dow hits rock bottom at 41.22, or 89% below its high in 1929. Many closed-end funds trade at 10% of their asset value.

1933: Group Securities, the first family of sector funds, offers aviation; home building; agriculture; distillery and brewing; chemical; electronics and electrical-equipment portfolios.

1933: Securities Act of 1933 requires funds to be sold with a prospectus disclosing their potential risks.

1934: Benjamin Graham publishes Security Analysis, the bible of professional stock pickers.

1936: Paul Cabot and Merrill Griswold, who had rescued F.D.R.'s sons from a boating mishap, get him to back new tax rules for funds when Cabot yells, "Mr. President, this is a damn outrage!"

1936: The Securities and Exchange Commission is created to regulate the markets. Joseph P. Kennedy, father of J.F.K. and a notorious stock manipulator, goes straight as the SEC's first chairman.

1937: Thomas Rowe Price founds an investment firm in Baltimore. His long-term goal: to find "new businesses which will develop with the growth of the Air Age."

FUNDS 67

ASSETS 532 MILLION

AS OF 12/31/39

'40s HOT: market-timing funds NOT: stock funds

1940: Investment Company Act is passed, banning unsavory connections among fund managers, directors and investment bankers and restricting "pyramid" funds that invest in other funds. Strict rules for calculating net asset value are imposed. A provision to limit any fund to $150 million because larger sums "could not be efficiently managed" is dropped when critics protest that no fund would ever get that big.

1943: Boston lawyer and fledgling stock picker Edward C. Johnson II takes over the Fidelity Fund, a struggling portfolio with less than $5 million in assets--and the beginning of the company that will become Fidelity Investments.

1944: Keystone introduces the "Seven Step Plan," the first of a half-dozen new "formula timing" funds that try to time the market.

The 10 most widely held stocks among funds: North American Co., Montgomery Ward, Standard Oil, International Nickel, GM, John Deere, Socony-Vacuum Oil, Kennecott Copper, Commonwealth & Southern, American Gas & Electric.

1946: Commonwealth Investment Co., a fund in San Francisco, starts its "Multiple Purchase Program," the first plan allowing shareholders to reinvest their dividends and dollar-cost average without the customary 8% sales charge.

FUNDS 91

ASSETS 2 BILLION

AS OF 12/31/49

'50s

HOT: atomic funds, Canada funds NOT: bond funds

1950: John Templeton founds Growth Companies Inc., ancestor of Templeton Growth Fund. T. Rowe Price creates his first mutual fund, Growth Stock.

1951: The total number of mutual funds surpasses 100, and shareholders exceed 1 million, for the first time.

1952: Harry Markowitz publishes "Portfolio Selection" in the Journal of Finance, proving the value of diversification.

1953: Scudder International, the first foreign fund.

1954: Atomic Development Mutual Fund is launched, raising an explosive $10 million. Next come the Science and Nuclear Fund; Nucleonics, Chemistry & Electronics Shares; and the Missiles-Rockets-Jets & Automation Fund.

1954: The Television-Electronics Fund gains 67%, powered by such hot stocks as RCA and Clevite Corp.

1954: Fund companies begin selling more than $350 million in Canadian funds by touting a tax loophole for investors (closed by Congress in 1962).

1958: The dividend yield on stocks drops below long-term-bond yields for the first time; Wall Street sages say yield relationship will soon revert to "normal." Forty-one years later, it still hasn't.

More than $1 billion pours into mutual funds.

1959: Dwight Robinson, chief investment officer, MIT, makes the cover of Time, showing that funds have made it to the big leagues.

FUNDS 155

ASSETS 15.8 BILLION

AS OF 12/31/59

'60s

HOT: risky "go-go" funds NOT: risky "go-go" funds

1962: John Templeton begins buying Japanese stocks for as little as two times their earnings.

1964: John Neff becomes manager of Vanguard Windsor. Over the next 31 years he beats the S&P 500 by more than three points annually.

William Sharpe publishes "Capital Asset Prices" in the Journal of Finance, demonstrating that riskier investments should have higher returns.

1966: Gerry Tsai, former manager of the hot Fidelity Capital Fund, launches Manhattan Fund, hoping to raise $25 million; the public flings $247 million at him.

1967: Mutual funds earn their mightiest returns of all time. One-quarter of all funds earn at least 50%, and four gain more than 100%. But many borrow money, use risky options and improperly pump up their returns with privately traded "letter stock."

1967: The Enterprise Fund's Fred Carr has a TV in the bathroom of his Beverly Hills home so he can watch the stock market open while he shaves.

George Chestnutt, whose American Investors Fund returns 46%, says he loves to buy stocks not when they are cheap but after they have already gone up: "If you have hold of a kite and let go, that's the most dangerous thing."

1968: The go-go era is personified by the "Three Freds": Fred Alger of Security Equity Fund; Fred Carr of the Enterprise Fund; and Fred Mates of the Mates Investment Fund. A few years later, nothing is left of their hot returns but smoking ash.

1968: Economics professor Michael Jensen publishes "The Performance of Mutual Funds" in the Journal of Finance, claiming that most funds are unable to perform well enough over time to recover their costs. Nobody listens.

FUNDS 269

ASSETS 48.3 BILLION

AS OF 12/31/69

'70s

HOT: money-market funds NOT: stock funds

1970: Bernie Cornfeld's I.O.S., a "fund of funds" scam uniting hot managers like Fred Alger and Fred Carr, collapses in a welter of lawsuits and financial losses.

1970: Investment Company Act of 1940 is amended to limit layering of fees and raise standards for setting net asset value.

1971: Henry Brown and Bruce Bent offer the first money-market portfolio, the Reserve Fund.

1972: MONEY Magazine debuts.

1972: Nifty Fifty growth stocks, like Avon Products, trade at huge prices.

1974: Dreyfus CEO Howard Stein begins using the famous Dreyfus lion to promote the firm's Liquid Assets money-market fund.

1974: Fidelity Daily Income Trust, the first fund with check writing, is offered. Now funds can beat banks at their own game.

Paul Samuelson publishes "Challenge to Judgment" in the Journal of Portfolio Management. Most fund managers, he writes, "should go out of business--take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives."

John C. Bogle is fired from Wellington Management Co. and resolves to start the Vanguard group.

1975: Failed fund manager Charles Schwab founds discount broker Charles Schwab & Co. n Vanguard begins operations.

ERISA, the law establishing the 401(k) plan, passes after years of advocacy by Ted Benna.

1976: Vanguard offers First Index Investment Trust (now Vanguard 500 Index), the first retail index fund.

1977: Peter Lynch takes over a dormant fund called Fidelity Magellan.

FUNDS 524

ASSETS 94.5 BILLION

AS OF 12/31/79

'80s

HOT: bond funds NOT: stock funds

1980: The SEC's Rule 12b-1 takes effect, allowing funds to charge marketing fees.

1981: Congress creates the Individual Retirement Account.

1983: Fidelity Select Technology rises 52%, and analysts declare tech "the world's greatest growth industry."

1984: Fidelity Select Tech loses 17%, and tech funds lag the market for the next five years.

1985: Amid bond market boom, assets of bond funds surpass those of stock funds for the first time.

1986: Mortgage funds are hyped as "guaranteed" and "safe" investments, but accounting gimmicks inflate their yields. Option-income funds rake in $9 billion with "enhanced" yields.

1987: Bonds suffer their worst crash in years; mortgage and option-income funds begin losing billions of dollars.

1987: The October crash. S&P 500 loses 20.5% in one day. Best-performing fund of the year: Oppenheimer Ninety-Ten, which rises 93.6%.

1988: Junk bond funds become enormously popular--shortly before major underwriter Drexel Burnham goes bust and junk bond promoter Michael Milken goes to jail.

1988: The SEC requires funds to publish a number called "total return"; formerly, fund investors had to calculate the return themselves. Industry leaders protest that the public will never understand it.

The SEC allows "multiclass" shares, enabling funds to charge different prices to different customers.

FUNDS 2917

ASSETS 982 BILLION

AS OF 12/31/89

'90s

HOT: stock funds NOT: bond funds

1990: Average junk bond fund loses 10.3%.

Peter Lynch steps down at Fidelity Magellan.

1991: Morningstar introduces its "star ratings." By 1994, 75% of all new investments will go into funds with top ratings of four or five stars.

1991: Health-care funds are on fire, with returns of up to 121%.

"Short-term world income" funds, investing in European debt, are sold as if they were as safe as CDs.

1992: Charles Schwab starts OneSource, the first "fund supermarket."

European currencies go haywire; short-term world income funds lose up to 15%.

1992: Bill and Hillary Clinton propose health-care reform, and health funds lose 5%.

1993: Complex "mortgage derivative" funds earn remarkably high returns at remarkably low risk.

1993: Emerging markets funds gain 72%, and investors pour in more than $1 billion.

1994: Mortgage derivative funds lose up to 28% when interest rates rise.

Emerging markets funds fall more than 10%.

1995: SEC proposes measuring risk mathematically. Only trouble is, no one (least of all the SEC) knows how to do it.

1997: The SEC proposes the "profile" prospectus, urging funds to write in plain English--instead of the languages they had long preferred, Doublethink and Middle Slobovian.

1998: Emerging markets funds lose 26.8%, and disgusted investors yank out more than $3 billion in assets.

FUNDS 7343

ASSETS 5.5 TRILLION

AS OF 12/31/98

Note: Number of funds treats multiple-class shares as one portfolio

Sources: Wiesenberger, Ibbotson Associates, Investment Company Institute, Lipper Inc., Morningstar, Securities and Exchange Commission