An investor wanting to reduce the gamble in owning common stock must hold stock in a good many companies. Momentarily ignoring the existence of investment companies, suppose a man decides that for adequate diversification he should own stock in 50 companies, and for the companies he selects the average price per share is $30.
Conceivably he could buy one share in each company at a total cost of $1,500, plus at least $300 expenses. In return for his money, the first things he gets back are fifty stock certificates, which he must keep safe. When he sells a certificate at any time in the future Uncle Sam requires that he know when he bought it and the cost. Also, in the course of a year he will receive some 200-dividend checks, for a total of perhaps $60. The whole thing sounds silly, doesn't it?
This example suggests three points about an investor's obtaining diversification without using an investment company:
1. He must pay out at least a few thousand dollars, and not many investors start with that amount of money.
2. The expense incurred in making small, direct purchases of stock may be higher than on the same total amount bought through an investment company, especially if a buyer figures in the fees for later sale of the stock.
3. Even if an investor has capital enough to buy many times one share in each of 50 or more companies, he still takes on a lot of work in selecting and keeping track of so many companies, and in handling his certificates and dividends.
Another advantage of having considerable capital in one pool is that the fund can afford to pay the salaries of a competent manager and assistants. Aside from the sales charge, most of the expense incurred in a typical investment company is the fee paid to the group responsible for keeping the fund invested. Usually this fee is fixed at a rate equivalent to 1/2 of 1 percent of the fund's assets each year. Suppose a fund's capital is $25 million; 0.5 percent of this is $125,000, which the fund can pay for an investment manager, his assistants, and his expenses.
A fund far smaller than this may be able to hire a skilled manager, because he expects a rapid growth of the fund's assets, and consequently of his management fee. Or the same management organization may be in charge of more than one fund, with some of the assets of each fund invested in stock of the same companies, thus reducing the work for each fund.
It appears that in 1959 the investment companies with the best performance records are apt to have assets of at least $250 million, either in one fund or in a group under the same management.
Large size also implies maturity. It is practically impossible for an investment company to accumulate $25 million of assets, let alone 10 times that much, until either the fund has been in existence for a good many years, or else its management group has an established reputation strong enough to draw capital rapidly into a new fund. In 1959 most of the funds, or groups of funds, with $250 million assets or more, are at least 25 years old. So a fund with a good performance record is apt to have age as well as size.
Of course, a fund can be large and still have poor or mediocre management. Large size merely gives a fund the opportunity for a fine performance.