Some tales are too revolting to repeat. Other tales are so revolting they must be repeated.
This is one of those ...
Bogle knows best
We all know that mutual funds, when picked imperfectly, can rob you blind. It's so bad, in fact, that Vanguard founder John Bogle showed how fund costs can steal up to 80% of your profits over a 45-year period.
But it can be even worse than that.
Revolting, indeed
A study was recently released by Professors Roger Edelen, Richard Evans, and Gregory Kadlec documenting for the first time the real consequences of trading costs on mutual fund performance. And they're not pretty.
We'll get to the ugly details in a moment, but the short version is this: Sell your small-cap mutual fund now!
Here's why
What the authors found is that "trading costs are the dominant source of diseconomies of scale in investment management." In plain English, that means that if you're invested in a large, popular fund with lots of assets under management, you're probably getting hosed.
What was more startling, however, was that the "negative impact of trading on performance is most pronounced for funds with a relatively large average trade size." So a big fund trading little stocks is at a huge cost disadvantage compared to a small fund trading small stocks, a small fund trading big stocks, a big fund trading big stocks, or an individual investor trading any stocks.
The significance of the disadvantage is startling. While funds trading large caps paid 0.32% per trade, funds trading small caps paid 1.32% per trade, according to data from Plexus. That's a full percentage point difference!
But that makes sense
See, large caps trade billions of dollars worth of shares each day, making it easy for funds that traffic in big positions to buy or sell without making lots of little transactions or artificially (and detrimentally) moving the stock price.
That's one of the reasons why the $44 billion Fidelity Magellan (FMAGX) fund doesn't count a single small company among its top holdings (despite small caps being the best-performing stocks on the market) -- and instead boasts the likes of $160 billion Google (NASDAQ:GOOG), $112 billion Schlumberger (NYSE:SLB), $18 billion Allergan (NYSE:AGN), and $13 billion Seagate Technology (NYSE:STX).
It's also why noted small-cap fund Royce Premier (RYPRX) closed to new investors after collecting just $5 billion in assets. With any more money on hand, manager Chuck Royce would find it difficult to build up meaningful stakes in top holdings such as $2.8 billion Unit Corp. (NYSE:UNT), $1.9 billion Fossil (NASDAQ:FOSL), or $2.3 billion Pan American Silver (NASDAQ:PAAS). And even the smallest holding in Royce's fund has a market cap of more than $600 million. If you take a look at that list of top stocks again, you'll see they all started off much, much smaller.
Of course, if you don't have $5 billion, then you don't have that problem.
Seriously, sell your small-cap fund
Mutual funds can be an important part of any investing portfolio. They can help you diversify, save time, and gain exposure to areas of the market in which you lack expertise.
But given the extra costs associated with small-cap mutual funds and their lack of agility when it comes to the smallest issues, it behooves you to take the small-cap portion of your portfolio into your own hands. And if you need to save some time, leave the large-cap investing in a low-cost fund.
Move forward, make money
At our Motley Fool Hidden Gems investing service, we're dedicated to helping more individual investors make money investing in small-company stocks. By focusing on businesses that are generating cash, have wide market opportunities, and are built for the long run, we've helped our subscribers beat the market by 34 percentage points on average.
You can take a look at our brand-new review issue -- released at 12 noon ET today -- in which we review all past recommendations and research and even rate our top five picks for new money now. To see the whole package, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe.
Tim Hanson does not own shares of any company mentioned. Unit is a Motley Fool Stock Advisor recommendation. Royce Premier is a Champion Funds pick. If you're a regular reader, you probably don't need to know anything more about the Fool's disclosure policy.
