Because the investor's experience with a mutual fund will determine how he feels about it much more than the fund's overall performance, new funds try to minimize the bad investor experiences. But no matter what the fund does, an investor can still have a bad experience, Phillips says. "Today, when funds are behaving better than any time since 1986, investors still chase performance."

Phillips has been tracking investor experience with funds and comparing that with the funds' performance. He finds that many investors still make the mistake of pumping money into a fund just as it reaches a peak. Then they ride down with the fund, and finally, when it reaches a trough, they sell in disgust. "The investor doesn't know what the fund did in total returns," he says. "The investor only knows his own experience."

Phillips looked at the 25% of funds with the highest volatility in each category and found that investors in these funds lost nearly 200 basis points to volatility. In the funds with the lowest standard deviation, he found that the investor captured almost all the return. Phillips suggests that an investor look at the "leaders and laggards," where he will find the same funds on one list or the other because high volatility funds either soar or sink, depending on the market environment.

And the exchange-traded fund market? Will it displace mutual funds? Not right now, Phillips says. As mutual funds become more tame, more predictable, more responsible and responsive to shareholders, ETFs will take their place on the wild and woolly frontier. ETFs are doing what mutual funds did in the '90s, he says-using leverage and letting the market decide which ones are good and which are not.

One of the warning signals is how willing fund companies are to follow trends. For example, Phillips points to the Internet fund craze during the tech bubble in the late '90s. As a litmus test, he looked at "Internet funds" and decided that those companies doing a good job for their shareholders weren't offering one.  This list included American, Vanguard, T. Rowe, Fidelity and Dodge & Cox.

Phillips suggests that such trend chasing is characteristic of the ETF world now. "There can only be so many S&P index funds," and so ETFs try quirky products based on a trend and let the market decide which ones work, he says.

Although Phillips likes the idea of ETFs, he thinks the market needs to go through the same learning curve as the mutual fund industry has. When he attends a mutual fund industry conference, he finds the fund industry "very humbled" by its recent woes, including the investigations by Eliot Spitzer, the disgraced former governor and attorney general of New York.

Phillips recalls testifying before the U.S. Congress following testimony by Spitzer, who was then the New York state attorney general. In a brief conversation after the hearing, Phillips says he objected to Spitzer's calling the mutual fund industry "a cesspool," and Spitzer's response: "Don, every rock I turn over, I find more vermin." Spitzer wasn't referring to his private life.

But ETF conferences are quite different from mutual fund gatherings. Here the participants are "very arrogant and talk about throwing product out into the marketplace and letting the market decide what works." However, Phillips, like other mutual fund observers, is intrigued by the new Wisdom Tree ETFs, which he predicts will create a good investor experience. The fund's cost is low-28 to 58 basis points-and the funds are tilted toward value because they invest in high-dividend stocks.

Over time, index funds haven't done any better than managed funds, Phillips says, passing on a quote he heard at a conference that "indexing is a more efficient way to have a bad experience."