Avoid These Mutual Funds - Be Like Goldilocks

Improve the performance of your investments with this Goldilocks approach:

These Funds are TOO LARGE:
Avoid actively managed funds with over $5 Billion in assets.
They face a dilemma of avoiding buying such a large percentage of a company’s assets that it becomes an affiliated company rather than an investment, or find that buying or selling a large stake in a company without affecting the market.

If they don’t take a large stake in each company, they are forced to invest in so many different companies that each investment doesn’t make a significant impact on fund performance, and they could need to follow hundreds of investments. Think about it - $10 Billion invested $10 million at a time means you need to follow 1,000 investments. To keep that many balls in the air you need to hire a lot of jugglers.

These Funds are TOO Small:
Choosing a fund that is too small means that either the fund family will need to temporarily subsidize the fund’s expenses, or you are going to get socked with high fund expenses. Do the math - if you are investing in a $100 million fund with a 1% expense ratio, that leaves the fund with $1 million to cover all their overhead, auditing costs, filing fees, promotional expenses, customer service, and pay for analysts, traders, computers, subscriptions, and all the other things needed to run a fund. Now a 1% expense ratio is not cheap, and you’d better be getting consistently better results than a comparable index fund, but there are plenty of funds that have expense ratios that are higher than this. Just don’t expect low expenses in a fund that is sized below $100 million in assets, but start to wonder what’s going on if a domestic fund has over $1 billion in assets and still has an expense ratio over 1% - just what are they doing with $10 million in expenses?

So Which Funds are Just Right?

Large Index Funds are OK to Own:
Index funds, on the other hand, don’t need to decide which issues to invest in - the index says which ones they need to choose and what percentage to invest in each one, so a computer can place all their orders and manage their portfolio. A well run index fund with the right systems and computer technology in place can operate with minimal expenses and with minimal turnover, which further reduces expenses and tax-related costs from realized (reportable) capital gains. Here is a case where bigger IS better, and you will benefit from the economies of scale.  For example, Fidelity’s Spartan Index 500 fund has an expense ratio of 0.1%

Actively Managed Funds Should be Medium-Sized
An actively managed fund should be large enough to keep its expense ratio reasonable, and small enough to be manageable.  Comparing two large cap growth funds, Fidelity Contrafund, and $80 billion giant that’s closed to new accounts, chalked up a 21.33% gain so far this year while managing over 400 stocks, while Fidelity Independence Fund, still overgrown at $5.9 billion in assets, gained 29.42% this year with a slightly lower expense ratio while managing 123 different stocks.

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