Our Picks for U.S. Stock Investors

Note: This article is part of Morningstar's December 2014 Guide to Better Investment Pickingspecial report. 

Becoming a better investor requires introspection. As Morningstar's Christine Benz describes in this article, you'll have to answer some key questions about the sort of investor you want to be before deciding how to go about it.

Once you've made those decisions, however, you'll need some investment options. Fortunately, there are plenty of good stocks, mutual funds, and ETFs to choose from, and Morningstar.com is just the place to start your research. Here, you'll find a wide variety of analyst picks and advice about making the best choices, regardless of your chosen investment style.

The following are some ideas to get you started with the U.S. equity portion of your portfolio, along with links to screens that list many others (Premium Membership required). The securities below aren't necessarily head and shoulders above their peers, but they represent good examples of best-of-breed investments of various types.

Wide-Moat Stocks
Morningstar believes that one of the best ways to identify stocks that are likely to outperform their peers over long periods is by seeking out those companies with economic moats--or, in other words, sustainable competitive advantages. Such advantages can be conveyed in several different ways, as explained here. Of course, it's also important not to overpay for moat stocks--look for those with 3 stars or preferably more, meaning those that are trading at or below our analysts' estimates of their fair value. (Also, pay attention to the stock's Fair Value Uncertainty rating, a gauge of how confident the analyst is about the fair value estimate.) Premium Members can click  here for a full list of wide-moat stocks with 3-, 4-, or 5-star ratings. Below are two examples. 

 Exxon Mobil (XOM): This integrated oil and gas company historically set itself apart from the other majors as a superior capital allocator and operator, delivering higher returns on capital relative to peers as a result. Our analyst team expects Exxon to maintain its lead in returns but forecasts a decline from historical levels due to reliance on higher-cost projects to replace reserves.

 Microsoft (MSFT): Microsoft is a tale of two companies: a lagging consumer software and devices firm and a firm whose dominance in the enterprise software world is growing. The company remains a cash flow juggernaut, generating more than $26 billion in free cash flow in the past fiscal year and with more than $85 billion in cash on its balance sheet. The technology powerhouse has the financial flexibility and resources to remake itself.

Active U.S. Stock Funds
Looking for a fund manager who chooses which U.S. companies to invest in on your behalf? Then what you want is an actively managed stock fund. But before picking one, make sure you know what our analysts have to say. Premium Members can find a list of all analyst-recommended actively managed large-cap stock funds (meaning those that carry a Morningstar Analyst Rating of Gold, Silver, or Bronze) by clicking  here. The list, and those that follow, exclude institutional share classes and funds closed to new investors. Below are two actively managed U.S. stock funds that make the cut.

 Oakmark (OAKMX): During a tenure of nearly 14 years, Bill Nygren and comanager Kevin Grant have delivered strong results with a straightforward strategy. From a universe of the 250 largest U.S. companies as defined by revenue, book value, and net income, the pair picks stocks whose prices imply a discount of at least 40% to their estimate of the business' actual worth. As impressive as the fund's track record is, investors should be comfortable with an approach that equates volatility not with risk but rather with the potential for reward.

 Vanguard Dividend Growth (VDIGX): Manager Don Kilbride looks for companies whose managements have proved willing and able to increase their dividends over time but whose shares are trading at reasonable prices. Ideally, the fund wants companies that can grow their dividends at the rate of inflation plus 3%. Often, Kilbride finds firms with five-year dividend-growth rates of at least 10%. The fund's favorite holdings tend to be large blue-chip stocks that have big competitive advantages.

U.S. Stock Index Funds
If you're more inclined to seek out market-level returns while potentially saving money on fund expenses, consider an index fund. But not all index funds are the same. Some do a better job of tracking their benchmarks and/or cost less than their competitors. In many cases, exchange-traded funds tracking the same index are also available, often at a lower expense ratio. Premium Members can click  here for a list of analyst-recommended large-cap index mutual funds, including the following:

 Fidelity Spartan Total Market Index : This fund covers virtually the entire U.S. stock market, holding around 3,350 stocks. Investors could use this fund as a standalone holding for exposure to U.S. stocks or pair it with individual stocks or other funds.
ETF alternative:  Vanguard Total Stock Market ETF (VTI)

 Vanguard 500 Index (VFINX): This fund is a suitable passive option for those looking to establish a core portfolio allocation to large-cap U.S. equities. Investors have a number of options for exposure to the benchmark S&P 500 Index. However, Vanguard's at-cost pricing structure and operational expertise give this fund an edge.
ETF alternatives:  iShares Core S&P 500 (IVV),  Vanguard S&P 500 ETF (VOO)

Strategic Beta Funds
If you're looking for a fund that lands somewhere in between an index fund and one that's actively managed, a strategic beta fund may suit your needs. Such funds emphasize stocks with a given characteristic (sometimes called factor-based investing), such as its level of volatility or how profitable the company is.

 AQR Momentum (AMOMX): Momentum-investing is based on the premise that securities that have recently outperformed will continue to do so in the short run, and those that have underperformed will continue to lag. This fund invests in the best-performing third of the U.S. large-cap market over the most recent trailing 12 months, excluding the most recent month. Both market cap and relative momentum determine each holding's weighting in the portfolio.The fund carries a high investment minimum, but it is waived for investors who access the fund through a financial advisor.
ETF alternative: iShares MSCI USA Momentum Factor (MTUM)

 iShares MSCI USA Minimum Volatility (USMV): A suitable core holding for conservative investors seeking exposure to stocks but with less volatility than a traditional stock portfolio. It attempts to construct the least volatile portfolio using the constituents of the MSCI USA Index, a broad index composed of the largest 600 or so U.S. stocks. Because the portfolio targets lower volatility, it should be less sensitive to fluctuations in the broader market and should hold up better during downturns. However, it will also likely underperform in bull markets.

Value Funds
One tried-and-true approach to stock-investing emphasizes owning companies whose stock prices appear cheap relative to their earnings or other valuation metrics. There are many good choices when it comes to U.S. large-cap value funds, and you'll find a list of those our analysts like  here. It includes the following:

 American Funds American Mutual (AMRMX): This fund has three goals: current income, capital growth, and conservation of principal. The fund's five managers and two analyst groups, who run their portfolios separately, invest primarily in high-quality, attractively valued, dividend-paying securities. (This fund may carry a sales load.)

 Dodge & Cox Stock (DODGX): This fund invests in mostly large-cap stocks that look cheap on a range of valuation measures. Management relies on bottom-up, fundamental research and favors businesses with good management, competitive advantages, and good growth potential. But these also may be businesses that are under a cloud. The managers clearly commit to their best picks, with about a third of assets in the top 10 and a turnover rate of 15%.

Small-Cap Funds
To properly diversify your portfolio, consider allocating a portion of your domestic-stock holdings to smaller companies. Our analysts like the following U.S. small-cap funds, as well as those found  here.

 Diamond Hill Small Cap (DHSCX): Lead portfolio manager Tom Schindler takes a classic approach to value investing, buying companies when their market price is lower than his estimate of their intrinsic business value and selling them when they reach that value. Schindler's long-term outlook results in lower-than-average turnover compared with most small-value funds. (This fund may carry a sales load.)

 Wasatch Core Growth (WGROX): Managers J.B. Taylor and Paul Lambert like to build a relatively compact portfolio of 40-60 stocks with strong management teams, defensible business models, and consistent earnings across economic cycles. They look for smaller companies growing by 15%-20% per year and pay attention to the price they pay.