(MONEY Magazine) – This year marks a milestone: It's the fifth edition of the MONEY 100, our hand-picked list of the best mutual funds in the business. We published our first list in 1998--and what a time to have created a collection of funds to hold for the long haul! It has been a dramatic four years since. The tech sector boomed and busted, of course. Foreign stocks fell far behind the U.S. market, then began to catch up again. Most important for mainstream investors, the heady, historic blue-chip rally of the late 1990s came to an abrupt end in 2000. While some small-cap and value stocks have surged, by and large the market is still limping through a drearily extended downturn.

Through this extremely challenging period in market history, a gratifying number of our original choices proved their worth. More than half remain among our 100 favorites today, and the number would likely total 75 if you were to include the funds that we were forced to drop because they closed to new investors, were liquidated or lost the manager (or team) responsible for their success.

We're more than pleased with the numbers posted by our 54 old-timers. Forty-nine of them beat Standard & Poor's 500-stock index over the past three years (through May 31); 41 topped that benchmark over the past five years; and over the same time period four out of five ranked in the top third of their Morningstar style categories. Our more recent additions have fared well too. When we checked up on last year's roster, we found that 76 had outperformed the S&P 500 over the past 12 months and 89 had come out ahead of the index for the past three years.

The solid performance of our hand-picked group over the years bears out a basic tenet of investing: Diversify and conquer. Our lineup always includes funds with a wide variety of styles and strategies--growth and value, large-cap and small, domestic and foreign. So while a number of them are bound to trail the market in any given year, we are always bound to have a hefty complement of winners too. It may be tempting to shift all your money into those leaders, but if there's one thing we've all learned in the past few years, it's that the investing style that's white hot today may cool down tomorrow. The discipline to follow a diversified approach saves you from the kind of fad-surfing that will almost always drag you down; and it can bring you big profits when the markets turn, as they inevitably do.

Our favorite managers also demonstrate discipline. They stick with their carefully developed strategies, even when those approaches fall out of favor with a temperamental market. Take, for example, the managers at the Clipper Fund, three of whom are pictured on our cover. Jim Gipson, Michael Sandler and Bruce Veaco (shown), along with Peter Quinn and Kelly Sueoka, are committed to investing in undervalued stocks; if they can't find any, they'll hang on to their cash until they do. This adherence to a strict value style did not serve them well in 1999--but we advised investors to stick with them. Look at them now: In a miserable market, Clipper Fund is up more than 13% over the past year. Over 10 years, they've earned an annualized return of 18.1% for their investors, outpacing the S&P 500 by six percentage points.

In 1999, though, the sharpshooters at Clipper actually lost money, thanks largely to lawsuit fears surrounding Philip Morris, one of the fund's top holdings and a stock most people loathed. But Gipson and his co-managers stuck to their guns, adding to their Philip Morris stake when the stock was down in the $20s. Today, the tobacco and food giant's shares have rebounded handsomely to the mid-$50s. In a similar vein, the Clipper team is now taking on Tyco shares; Gipson says that "panic and hysteria over the unknown" have driven the price well below what the company's assets are worth.

Other great fund managers on our list apply the same discipline to wildly disparate investing styles. This year's big winner is Ken Heebner, who has been on our list from the get-go. This investing iconoclast earned shareholders in his CGM Focus fund 49.8% over the past 12 months, thanks partly to his savvy shorts on technology stocks. Leading the losers' list, down 34.1%, is high-growth, tech-heavy White Oak Growth Stock. But we haven't given up on the fund or its manager, Jim Oelschlager. A big gainer in the '90s, White Oak is likely to soar again when growth stocks come back. Between these extremes are funds representing a variety of styles and strategies, like Mairs & Power Growth, which holds steady-growing companies for decades, and RS MidCap Opportunities, which buys and sells stocks at a frantic pace. Why? Manager John Wallace simply follows his own systematic program for taking profits and cutting losses on his fast-moving growth picks.

LETTING GO OF GOOD FUNDS (AND BAD)

This year, we've wistfully let go of eight funds because they either grew so popular that they closed to new investors or they lost a talented manager who was integral to their past success. A ninth, Longleaf Partners Realty, was liquidated because the managers were not finding enough investments that met their demanding criteria.

If we can find a way to hold on to tried-and-true managers, we do. When Kern Capital Management's Fremont U.S. Micro-Cap closed in 2000 (it has since reopened), we took on the firm's Fremont U.S. Small Cap instead. We lost another member of the '98 lineup when Sarah Ketterer and team left Mercury HW International Value (formerly Hotchkis & Wiley International) last year. This year, we're thrilled to welcome the crew back, with the new Causeway International Value (see the box on page 83).

We can't say we're sorry when funds close. One sure sign of a great manager is a willingness to close a fund to avoid being overwhelmed with cash; the pressure of putting a flood of new money to work can lead a manager to tamper with a successful strategy. If you already own one of the six MONEY 100 funds that closed in the past year (see the table on page 84), consider yourself lucky. And if you don't, keep an eye out for reopenings, particularly at Fidelity Low-Priced Stock: This $18 billion behemoth may well reopen after it digests recent inflows. Manager Joel Tillinghast has an unusual knack for running a truckload of money in true small-value fashion.

We dropped MSIF Mid Cap Growth and Small Cap Growth because their lead manager, Arden Armstrong, left Morgan Stanley early this year. Since the new managers don't have lengthy track records, we can't wholeheartedly endorse them. But that doesn't mean you shouldn't hang on and give them a chance, especially if selling your funds would create a tax bill. Indeed, the fact that we have dropped a fund is never enough reason for a current investor to bail out. We're committed to presenting a list of what we believe to be the best 100 funds to buy now. Just because a fund fails to make the cut doesn't mean it's a clunker. For one thing, we omit many solid funds simply because we already have plenty of outstanding choices in a particular style.

Other funds disappear from our list because they no longer consistently outperform peers with similar investment styles. This year, we culled out SSgA Growth & Income, Homestead Value and TIAA-CREF Growth Equity because of their prolonged subpar results. Again, just because these funds don't qualify for a list of today's best, doesn't mean they are automatic sells for every owner. We believe we had good reason to drop Jean-Marie Eveillard's SoGen International in 1999: Its performance was suffering and the firm running it was on the block. After the fund was smoothly integrated into the First Eagle family, we brought it back in 2001. Now called First Eagle SoGen Global, the fund gained 15.8% over the past year.

Finally, while the socially conscious Domini Social Equity has done fine for a large-cap fund, we think its 0.92% expense ratio is high for an index fund. There is now cheaper competition that wasn't available when we chose it in '98. We've replaced it with the two-year-old Vanguard Calvert Social Index.

HOW WE CHOOSE THE 100

Our basic fund-picking criteria haven't changed over the years. First and foremost, we want funds that have consistently posted competitive returns over the years. In general, that means they either trounce most of the funds in their peer groups or deliver steady returns with moderate risk. We also want them to show every promise of continuing their success. That means sticking with managers we know and trust to take us through the down times--managers like Richard Freeman of Smith Barney Aggressive Growth and Glen Bickerstaff of TCW Galileo Select Equities. Their large-cap growth portfolios have lagged the S&P 500 lately, but their long-term numbers give us faith that they will return to their winning ways.

We also favor funds with moderate expenses, because high costs lower a fund's prospects for future outperformance. We've made a few exceptions, including Longleaf Partners International, which has annual expenses of 1.82%, above the 1.67% average for all foreign funds. But a small foreign fund is relatively costly to run, and the Longleaf team has proved to be worth every penny. If you're a committed mutual fund bargain shopper, you can identify the cheapest deals on our list by looking for the Low Cost icon in the tables that follow on page 86.

Our latest additions to the 100 are branded with a New icon. We continue to emphasize large-cap funds--we feature 41 of them--because they are the mainstay of any portfolio. Among the funds making their debut this year is Pelican, the sole retail offering of institutional money manager Grantham Mayo Van Otterloo (see the box on page 81). We also added Fidelity Growth & Income (see the box on page 85). Managed for the past 10 years by Steven Kaye, this fund has great long-term numbers and is, like the American funds (profiled below), a mainstay of many 401(k) portfolios.

Some of our choices, like the above-mentioned White Oak Growth Stock, are for aggressive investors only. At the other extreme, T. Rowe Price Equity-Income is one of the safest ways to invest while still owning stocks. Similarly mild-mannered picks are flagged with a Low Risk icon; these funds have been less volatile than the S&P 500 and they have Morningstar risk scores in the lowest 10% of their style categories.

We're light on the kinds of funds that are peripheral to most investors' portfolios. This is by choice. Emerging markets, for instance, have surged in recent months, and funds that focus on these volatile areas are in the spotlight. But we didn't rush to add to the two reasonably diversified, relatively conservative names already on our list, SSgA Emerging Markets and T. Rowe Price Emerging Markets Stock. Same goes with sector funds. We considered adding a communications fund to the technology, health-care, financial and real estate offerings represented; the downtrodden communications sector is potentially a source of great values these days. But we don't believe that the sector is as obvious a portfolio diversifier as the others are. And, since some of the talented managers on our list--including original picks Wally Weitz of Weitz Value and Mario Gabelli at Gabelli Asset--are making savvy telecommunications and media bets, we decided that we didn't need to dabble in a new sector play ourselves.

Between the large-cap core holdings that are the bulk of our list and the sprinkling of for-the-experts extras like emerging markets and sector funds, we've maintained a broad roster of midcap, small-cap and foreign funds. All but the most conservative investors usually round out their portfolios with such choices.

HOW TO BUILD YOUR PORTFOLIO

We've selected our 100 favorites. Now it's your turn to narrow down the list to fit your own needs--that is, your investment goals and risk tolerance. Aficionados may want to jump right in and browse the tables that begin on page 86. In addition to performance statistics and portfolio information, we've included a comments section that gives you the gist of each fund's strategy and what sets it apart.

Overwhelmed and wondering where to begin? You could start by taking a look at what you now own. If you've already got the large-cap basics covered, then you can head to the small-cap section of the table to read about picks that can add an edge. Also check to see how your current funds stack up against the ones we like. Perhaps you'll choose to trade up, particularly if you're investing via a 401(k) or an IRA and don't have to take taxes into account should you sell any of your current holdings.

As you weigh your options, think about balancing large-cap picks with smaller-cap funds, and funds that follow value-oriented strategies with more aggressive growth picks. We have grouped diversified domestic funds by market cap and indicated next to each name whether Morningstar classifies it as a growth or value offering, or a blend of the two. Above each fund's total return numbers are icons indicating how it compares with others of the same style.

You can also check out a fund's five largest holdings to see how much overlap it has with your current or prospective picks. You'll find, for example, that Vanguard Tax-Managed Capital Appreciation--which we added precisely for people who don't want to worry about taxes in an ordinary account--has a lot in common with the Vanguard 500 Index and might not make a good supplement to a core index fund, even though it is more growth-oriented.

To help you make your choices, we constructed three model portfolios using funds from the 100. (For bond funds to fill the fixed-income portion of your allocation, see page 80.)

MODERATE PORTFOLIO. Let's say you have a reasonable amount of risk tolerance and can afford short-term losses because your goals--whether the kids' college, a new house or retirement--are seven to 10 years in the future. The moderate asset-allocation pie chart at the left shows a typical allocation guideline for such a case. Suppose that you anchor your portfolio with a broadly diversified large-cap fund, say Oppenheimer Main Street Growth & Income or Vanguard 500 Index. You might round that out with a midcap growth portfolio such as Calamos Growth, which would have added pop in 1999, and then set that pick off by value-oriented small-cap fund Royce Micro-Cap, one of the best places to be when growth crashed in 2000. Artisan International would add foreign growth stocks to the mix without getting reckless; Oakmark International applies Oakmark's renowned value formula overseas.

CONSERVATIVE PORTFOLIO. As sensible as our moderate proposal may be, it might nevertheless be a bit much for investors who dread downturns or can't afford a misstep because they are low on ready cash and planning to retire soon. Conservative investors will stash more cash in bonds and stick with low-risk stock investments. Large-cap value fund T. Rowe Price Equity-Income could conceivably lose money, but it hasn't in any one year since 1990, thanks to an old-fashioned emphasis on dividend-paying stocks. A growth-oriented--but still eminently sensible--large-cap pick such as American Funds' Growth Fund of America might be tempered by a small stake in an income-oriented real estate fund such as Cohen & Steers Realty Shares, which is leaps and bounds ahead of the S&P 500 over the past three years. Tweedy Browne American Value and T. Rowe Price Small-Cap Stock would add midcap and small-cap oomph. Meanwhile, Putnam International Growth would provide foreign-stock diversification.

AGGRESSIVE PORTFOLIO. There are the iron-stomached investors who didn't even flinch when they opened last quarter's statements. And then there are those who are planning on working and saving for another decade or more. But even if you are a daredevil with time to kill, you might want to kick things off with a reliable large-cap index fund. Vanguard 500 Index is the classic choice; Vanguard Calvert Social Index is an alternative for socially conscious investors. Marsico Focus would add highly concentrated spice; RS MidCap Opportunities would pump up the growth.

(Note that RS MidCap Opportunities, like seven other funds, is marked with an icon indicating that it's best sheltered in a tax-advantaged account. The fund's rapid-trading strategy is profitable but not tax-efficient, and you will maximize growth by postponing taxes in a 401(k) or traditional IRA or by avoiding them altogether in a Roth IRA.)

Even value picks needn't be stodgy. Bob Rodriguez flouts conventional wisdom at small-cap FPA Capital with controversial picks like insurer Conseco, and Wally Weitz has loaded up Weitz Value with floundering midcap telecom and media names. With a broad foundation laid, a few flourishes can add dash without courting structural damage: An aggressive investor might divert some of his or her stock stake to a 5% position in Pimco RCM Global Technology or SSgA Emerging Markets, for example.

The three asset-allocation charts shown here are just several of many ways to slice the pie. For more on allocating assets, we cover the basics at www.money.com/pf/101/lessons/15/, where you'll also find a calculator to measure your own risk tolerance and time horizon. Brokerages such as Fidelity and Schwab offer similar online tools, as do major fund companies such as T. Rowe Price (www.troweprice.com) and Vanguard (www.vanguard.com).

Likewise, our model portfolios of picks are simply a starting point. We've given you 100 funds to play with, which means that there are more possible combinations than we can count. Dig in!