Can a Mutual Fund Grow Too Large for Its Own Good?

Investing in a mutual fund has become one of the most popular investment strategies in the world today. Mutual funds offer diversification for their clients. However, it is possible for mutual funds to grow too large. Here are a few things to consider about excessive growth in mutual funds.

Flexibility

One of the major advantages of investing in mutual funds is that you are diversified as an investor. You pool your money together with many other investors and buy thousands of securities. This allows you to maintain your portfolio even if one or two individual securities do not perform well. It provides you with sustained growth over the long term. However, with mutual funds when you get to a certain point they cannot perform as well as they once did.

When mutual funds get too big, they are no longer flexible. In order to buy securities for the fund, they have to spend millions of dollars at a time. Any time this happens, it is impossible to keep your moves a secret because by the time you buy enough securities, everyone else in the market already knows about it. When dealing with stocks, you want to be able to get into the market early and buy at the best available price. When other investors know what you are doing the price of the securities will go up before you buy. This lowers the overall return of the mutual fund and therefore hurts the investors in the fund.

Management Difficulties

Mutual funds or managed by fund managers that make all of the investment decisions for the fund as a whole. Many of these large mutual funds rely on one person to make every decision for the fund. They do the research, they find the investments and they decide how much to buy. Therefore, many people are depending on one person for their investment success.

When a fund is smaller, it is much easier to manage for the fund managers. Managing millions of dollars can be a very stressful experience for an individual. Many wealthy people are counting on them to provide them with a good return on their investment. When they are performing everything is great. However after a series of bad investments, investors will start to lose confidence in the fund managers. It takes a very high level of self-confidence to manage other people's money. When you are doing it on a large scale it magnifies everything that you do. Therefore, the larger a fund gets the harder it is to find competent fund managers to run it.

Law of Large Numbers

When a fund is smaller, it is much easier to move under the radar. It has a much larger opportunity for growth as a result. As it grows it becomes more difficult to find investment strategies that actually work. Therefore, a smaller fund is actually better for growth.

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