However, lately this indicator has been much less reliable than decades ago when, before computers and a mutual fund industry, the most active securities traders were retired male individual investors who would congregate in the offices of big brokerage houses to socialize, sip coffee, conduct their investment business, and watch the young lady clerks rapidly and efficiently reaching up and down with pieces of chalk to manually update in large print and numerals onto nearby wall-length blackboards the latest of the New York Stock Exchange prices off the stock ticker.

Presumably under these conditions the old guys were the most stimulated when fashions dictated that the sweet young things cavorting closely before them displayed rising hemlines, and were then more prone to optimistically throw caution to the winds, placing far more buy than sell orders. Is it any wonder that when ladies' attire was a lot smaller bull markets tended to ensue?

Actually, though, in this issue we are focusing on other aspects of the wisdom that "small is beautiful" where good investing is concerned.

In addition to the concern with lowering expectations, it may be noted that one's best prospect of returns similar to those to which investors had earlier been accustomed derives from a careful purchase of very small companies' stocks.

Researchers have long thought that small-cap equities had higher returns than those of their large-cap brethren. Now the American Association of Individual Investors (AAII) has further evidence supporting this idea. For ten years they managed a "Beginner's Portfolio" of exclusively micro-cap stocks with quite low price to book value ratios. This actual portfolio, despite taking into account both commissions and the losses due to bid-asked spreads on quite small companies' securities meeting their criteria, has outperformed the S & P 500 Index by an annualized 4+% through that period (13.3% vs. 9%, respectively, through 12/31/02). On a cumulative basis, this means that, exclusive of taxes, each $1 invested in the Beginner's Portfolio ten years before, with assets replaced, as they no longer met the criteria, by those that do, would have been worth $3.49 at the end of 2002, despite the ravages of the recent bear market. During the same period, exclusive of taxes, each $1 invested in the Standard and Poors 500 Index would have risen to $2.37. (Source: "AAII Journal," the April, 2003, issue, "The AAII Beginner's Portfolio: An Annual Performance Review," pp. 33-36.)

It seems clear that small- or even micro-cap equity holdings should be a major part of everyone's long-term nest egg.

If your broker will be directing the portfolio for you, it's a different story, of course. A reasonable management fee then is quite appropriate. You have a right to expect in that case that he or she has a good record of money management, beating the averages for several years, relative to the corresponding risk-adjusted benchmarks. (For instance, through 12/31/02 and over the last decade, per AAII, the average annual return of a 40% Lehman Aggregate Bond Index and a 60% S&P 500 Index was just slightly below 8.9%. A $10,000 investment, so allocated and left invested for the decade ending 12/31/02 would then be worth $23,546. Source: The Vanguard Group, "In the Vanguard," p. 5.) Otherwise, your fee might be better spent on an investment in successful, tax efficient, no load index funds. There are a number of these with yearly management fees as low as .3% or less. (Of course, the decision to use a full service broker and/or to pay him or her a standard fee may have other motivations, which I do not mean to denigrate. One might, for instance, simply wish the reassurance of a trusted relationship, which very well might count for more than a precise calculation of costs vs. benefits.)

Besides index funds, a few carefully selected managed mutual funds offer records of superior returns over many years. These, particularly if they have a low total of loads and/or all fees (generally 1.5% or less a year), deserve serious consideration. Some of the best of them provide the manager a small higher fee incentive payment for beating the averages, with a reduction in his or her fee if this goal is not achieved.

In a lower overall rate of performance scenario, keeping fees or commissions small will be more important than ever and will pay large dividends over the long-term.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)