Let me ask: Why are you invested in that mutual fund?
If you're like me, you probably have a list of reasons, including the fact that your 401(k) offers only a few mutual funds, so you had to choose one. Even so, there should be only one reason we're in any managed fund: To beat the market.
That's something we all want to do, but today I'll give you one reason why your fund may not: Size.
The Lynch lesson
I remember many years ago reading that the Fidelity Magellan (FMAGX) fund had reached the $15 billion mark in assets -- a staggering amount at the time. Peter Lynch had done such a great job picking stocks that the money was pouring in. Today, with Lynch long gone, the assets have reached more than $50 billion -- larger than some countries' GDP. And it's harming returns. (To wit: Fidelity recently changed the management at Magellan with the hope of spurring performance.)
Why does size matter? Because as a fund grows larger, its manager grows less nimble and more conservative. He loses the ability to invest in smaller companies because he simply can't buy enough shares to create a meaningful position without seriously affecting the stock price. As a result, the top holdings lists of many giant funds hew to the S&P 500.
So, while Lynch was able to get into (and out of) small- and mid-cap stocks, new Magellan manager Harry Lange cannot -- and is heavily invested in enormous firms such as Google (NASDAQ:GOOG), General Electric (NYSE:GE), Nokia (NYSE:NOK), and UnitedHealth (NYSE:UNH). Investment Company of America (AIVSX), a fund with $70 billion under management, is also forced to ride large caps such as Altria (NYSE:MO), AT&T (NYSE:T), and Tyco (NYSE:TYC).
Individually, each of these large caps could beat the market for years to come. But taken together, they start to become the market. See the problem? Any bloated funds that resemble the S&P begin to track the S&P. At that point, you might as well dump the fund and its higher expenses and jump into a low-cost index fund.
Set your sights higher
You shouldn't be paying a big premium to invest in what amounts to a glorified S&P 500 index-tracker -- particularly if your goal is to beat the S&P. Fund expert Shannon Zimmerman, of Motley Fool Champion Funds, searches every day for the managers who aren't weighed down by a large asset base, who have a proven track record, and who have a large stake invested in their own funds.
If you'd like a look at the funds he's recommending, you can do so free of charge. His recommendations are beating the market and equivalent benchmarks 24% to 12% since the service began two years ago. To try it free for 30 days, click here.
UnitedHealth is a Stock Advisor recommendation. Tyco is an Inside Value recommendation.
Rex Moore is a closet member of the Jack Horkheimer fan club, and reminds you that Saturn is well-placed for viewing in the eastern sky. He owns no companies mentioned in this article. The Motley Fool has a slim, trim, and nimble disclosure policy .
