With mutual funds, costs count. Because they get subtracted directly from returns, high fees can turn an above-average portfolio into an also-ran. But investors rarely see their fund's full bill. Reporting only what they can measure, accountants ignore trading costs when computing a fund's expense ratio.

Happily for investors, Barra, a research firm in Berkeley, Calif., has spent the past few years correcting this omission, developing a model that estimates a portfolio's trading costs. At the request of Morningstar Mutuals, Barra recently ran its Market Impact Model on a dozen of the country's largest stock funds. Funds with the lowest trading costs tended to share three traits, according to Morningstar: slow-motion trading styles, relatively small asset bases and blue chip portfolios.The clear winner in the trading-cost game among the 12 funds was Franklin Growth, with trading costs eroding assets by only 0.02 percent annually. The fund buys big stocks and holds them indefinitely, turning over only 1 percent of its portfolio annually (compared with a turnover rate of 99 percent for the average domestic equity fund). Several other low-turnover funds nearly tied Franklin Growth, including the behemoth Vanguard Index 500, which tracks the blue chip Standard & Poor's 500-stock index.

From these very low totals, the next group of test funds takes a large jump, to roughly 1 percent in annual trading costs. The three funds, Fidelity Magellan, Washington Mutual and Janus Twenty, all own very big stocks and sport unremarkable turnover ratios of about 40 percent. But Barra's estimate serves as a reminder that even slow maneuvers can be difficult when carrying an enormous asset base. The average stock position in Janus Twenty has a value of nearly $1 billion; it's hard to sneak a billion-dollar trade past the market.

Things got a lot worse when Barra left the world of mainstream blue chips. Small-value fund Fidelity Low-Priced Stock and aggressive-growth Putnam New Opportunities take a huge step up the cost ladder, scoring a depressing 3 percent.

And finally, there's Van Wagoner Micro-Cap Fund. It ran up trading costs of 14 percent a year by churning through an entire portfolio of microcap stocks every three months. Although, if you collected the 200 percent total return for the fiscal year ended last August, you're probably not complaining.

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Considering the difficulty of measuring trading costs, they shouldn't be the only factor influencing investment decisions, concludes Morningstar.

"Before buying any fund, consider the stated expense ratio and do a quick calculation of hidden costs, considering the portfolio's turnover and the size of its holdings. For example, a small-cap fund with a turnover rate of more than 120 percent is likely to face a serious handicap. In the end, you may find some funds so compelling that they're worth the steep trading expenses. But most of your money should go into funds without those hefty costs."

(Morningstar Mutuals, 225 W. Wacker Drive, Chicago, IL 60606; bimonthly, $395 monthly)

This column is a digest of investment opinion from the world's leading financial advisers. It does not recommend any specific investments, and no endorsement is implied or should be inferred. For more information, contact the individual firms cited.

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