Pluses, Minuses of Investing in Small-Company Funds.

Both the delights and the frustrations of investing in "emerging growth" stocks are plainly on display at the Invesco Small Company Growth Fund.

Like many of its competitors, this $800 million fund spent much of the mid- to late-1990s struggling while the stock-market crowd chased after big growth companies.

Then it came on with a rush in 1999, getting especially hot in the fourth quarter, to remind the shareholders why they put their money in small stocks in the first place.

"When these stocks move, they move fast," said Stacie Cowell, 32, who started her financial career in 1989 and has been Invesco Small Company Growth's manager since mid-1996.

Her fund is old enough to have established a record, and still small enough to maneuver in its specialized field - worthy characteristics that helped earn it its place as our case study today.

The biggest holdings among the 130 stocks the fund owns include the computer software company BindView Development Corp., whose shares jumped 152 percent in the fourth quarter, and Pinnacle Holdings Inc., an operator of towers for wireless communications, which had a fourth-quarter gain of 62 percent.

Erratic behavior

If you measure a small-stock fund against the Standard & Poor's 500 Index, you're really comparing grapes to grapefruit. But we're going to do that anyway, since you and I have the choice of putting our money either in small stocks or in an S&P 500 index fund.

From the end of 1995 to the end of 1998, Invesco Small Company averaged a 14 percent annual return, half the S&P index's 28 percent yearly gain. In 1999, by contrast, the fund soared 82 percent, almost quadrupling the S&P's 21 percent return. In the last three months of the year, it jumped 47 percent.

Now, Small Company's five-year return, at 27.3 percent a year, virtually matches the S&P's 27.5 percent for the same period. That was good enough to rank the fund ahead of 93 percent of all funds and 89 percent of funds that specialize in small stocks, according to Bloomberg Fund Performance.

As recent history shows, important differences lie behind the similar results. The behavior of small stocks can be much more erratic than the big household names. "It's a volatile category, and I expect it to remain so," Cowell said.

A small-stock fund also may hit you with big taxable capital gain distributions now and then, because of frequent trading of the stocks it owns. Since 1996, Morningstar Inc. data show Invesco Small Company averaging turnover of about 200 percent a year (meaning it keeps its stocks an average of about six months), versus an industry average of about 90 percent.

"Investors may want to put this one in a tax-advantaged account," suggested Morningstar analyst Valerie Putchaven.

Managers of funds with small market capitalizations face several constraints that don't affect large-stock funds. Small-cap stocks are tougher to buy or sell at favorable prices, because their shares aren't as actively traded.

Cash is valuable

In an age when many managers keep cash in their funds to a minimum, Cowell maintains a reserve of about 10 percent. "I always like to have some cash for redemptions," she said. "In a down market, you're going to get some redemptions and you also want to be able to buy stocks."

Since it's hard to sell illiquid small stocks to buy others when the market is falling, cash on hand is valuable.

Small-stock managers often are forced to sell their biggest winners as they outgrow the category. "It is hard sometimes," Cowell admits. "But if you don't do this you're going to find that you're a mid-cap fund. You have to be able to give people what you're advertising."

Lately, the biggest winners among small-cap stocks have been concentrated in the computer and telecommunications businesses. About 44 percent of Invesco Small Company's investments are in what it classifies as "technology."

For all the obstacles, Cowell says the case for emerging-growth investing remains strong. "I still think that over time you can get higher earnings growth out of small companies," she said.

If a fund of this kind attracts you, count on it to teach you something about patience.

Chet Currieris a coluninistforBloornberg News.

Fund Investors Should Do Own Tax Returns

All right, listen up, mutual fund investors. The assignment is to ditch your hired tax preparer and do your own income tax return this year.

We realize this is nobody's idea of fun. But a few hours going eye to eye with those Form 1099s and Schedule D could teach you more about fund investing than a month of abstract research.

For instance, to figure out how much money you made or lost when you sell fund shares, you need to know your cost basis (the total price you paid) to do the arithmetic. To figure your cost basis, you have to have a pretty clear idea of how fund distributions work. if you can't figure your cost basis, chances are you ought to get more involved. This is your money, even if somebody else is managing it.

You don't have to fight the battle unarmed. There's a choice of tax-preparation software packages that do most of the dirty work. They can be frustrating to navigate at times, but they'll usually get you through if you stay patient.

By all means, have a professional preparer check your work if you're not sure of yourself. We don't want anybody getting hurt Out there. The idea is simply to learn first-hand what you're up against.