Life is full of contradictions: Think of the adages "out of sight, out of mind" and "absence makes the heart grow fonder." It's the same with investing.
Consider mutual funds. You want to invest in successful ones, and many of the most successful ones are big, because their success attracted many investor dollars. But being big can hurt a fund's performance when its managers have trouble finding enough great investments for all that money. And despite all that, some big funds still do manage to perform well, and better than many smaller peers. It's enough to make your head spin!
Let's look at these issues a little more closely in the context of large mutual funds.
If you were charged with investing a big mutual fund's money and turning in strong performances, you'd have a hard time of it, as mutual funds generally have strict rules that can make effective investing difficult.
For starters, you'd likely have to keep 5% to 10% of the fund's value in cash, to cover withdrawals when people sell shares. For example, the American Funds Growth Fund of America (AGTHX), with a whopping $133 billion in assets under management, recently had about 8% of its assets in cash. Money sitting in cash is going to have a hard time even keeping up with inflation in this low-interest-rate environment, so that money may well lose purchasing power over time.
You also probably wouldn't be able to invest more than 5% of the fund's value in any one stock, limiting you to no fewer than 20 stocks. Many large funds actually invest in several hundred stocks. The Growth Fund, for example, holds stock in about 300 companies. Its biggest holding was recently Apple
Consider three companies that you might be eyeing for your own portfolio: Corning
Those who want to invest in the three companies individually would have to follow them closely, as with most stock holdings. It might be tempting to let a mutual fund such as the Growth Fund own those stocks for you, but they're probably not going to move the fund's needle much, no matter how well (or poorly) they do. Las Vegas Sands makes up just 0.47% of the fund, while Corning represents 0.40% and Sirius XM Radio just 0.12%. Remember, they're three of 300-some holdings.
Note, too, that huge funds tend to hold stock in huge companies. If you're drawn to the potential of small caps, a big fund might not serve you well. Even if a big fund's manager loves Geron's
Of course, every rule has its exceptions, right? As a reminder that we should never rule out a fund just because of its size, there's Fidelity's Contrafund (FCNTX), with around $75 billion in assets and market-beating returns over the past three, five, 10, and 15 years. It's beating the market so far this year, too, perhaps because it has made some big bets among its 440 holdings, with 42% of its assets in its top 20 stocks. Those include Visa
What to do
When seeking great funds, we need to keep in mind that massive size can be a problem or at least a challenge for mutual funds. It can be smart to favor smallish funds with strong records, but don't automatically rule out big funds. And above all, consider fees along with performance. The Growth Fund, for example, charges a 5.75% front-end load, lopping off a big chunk of your investment before delivering returns that don't always beat the market.
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Longtime Fool contributor Selena Maranjian owns shares of McDonald's, Corning, and Apple, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of McDonald's, Visa, Apple, and Corning, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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