Generally the typical investor is better off investing in stock mutual funds than in individual stocks. A mutual fund is an investment vehicle where money from a large number of investors is pooled together and invested by a professional manager or management team. Mutual fund managers invest this pool of money in accordance with a predefined set of goals and guidelines.
One of the primary benefits of investing in mutual funds is the ability to diversify across a large number of different stocks. With mutual funds, you don’t need a fortune to invest in a broad spectrum of stocks issued by large and small companies from a variety of different industries and geographies. Diversification with mutual funds reduces risk by providing a buffer against extreme swings in the prices of individual stocks. You are less likely to lose a lot of money if an individual stock plummets. Unfortunately, you are also less likely to experience a huge gain if an individual stock skyrockets.
Another benefit of stock mutual funds over individual stocks is that less time and knowledge is required to create and monitor a portfolio. Most individual investors do not have the time, expertise, or resources to select and monitor individual stocks. Mutual funds hire hundreds of analysts to research and monitor companies, industries and market trends. It is very difficult for an individual to achieve this level of knowledge and understanding across a broad spectrum of companies. Mutual fund managers have the resources to easily move in and out of companies and industries as investment factors change.
Most individual investors appreciate the convenience of selecting and monitoring a diversified portfolio of mutual funds over the arduous task of selecting a large number of individual stocks Stock mutual funds are a good option for your serious money. However, if you really want to play the market and invest in individual stocks, use money that you can afford to lose.
For die-hard stock investors, there are some advantages to investing in individual stocks. Many stock mutual funds charge an annual management fee of between .50 percent and 1 percent (.25 percent for index funds). With individual stocks, there is a cost to buy and sell the stock but there is no annual management fee associated with holding stock.
Another advantage of individual stocks is greater control over when capital gains are recognized within a non- retirement account. When you own an individual stock, capital gains are not recognized until the stock is sold. In a high income year, you can delay selling your stock, and recognizing the gain, to a year when it would be more tax efficient. When you invest in a stock mutual fund, you have no control over capital gains on stock sold within the fund.
Jane Young is a Certified Financial Planner. Email questions for this column to firstname.lastname@example.org.