4 April 2013

Mutual funds or stocks?


With the range of investment options available for the individual investor it can be difficult to determine which investment is right for you. With stock markets up one day and down the next, many investors face the dilemma of whether to invest directly in stocks or to use mutual funds as their investment tool. In order to decide which approach best meets your needs, it is important to consider some of the pros and cons of each of them.

Philippine stock market board
Image credit: Katrina.Tuliao
Clearly, the answer will vary from person to person, depending on how much risk you are comfortable with, how much money you have to invest, how knowledgeable you are about financial matters and how much time and effort you are willing and able to devote to this task. Each approach to investing has advantages and disadvantages.

Do you have the knowledge, time or inclination to build your portfolio and monitor your investments yourself? Mutual funds are managed by experienced professionals who are well acquainted with the risks and opportunities that come with investing; they will make the day-to-day buy and sell decisions about which stocks, bonds, or other securities to invest in, thus relieving the investor of that responsibility. As with all investments, mutual funds will not perform to expectations all the time. To have the best chance of success, it is important to select a fund manager with a quality management team and a good track record, but even then, only a few funds will consistently outperform the market.

If you decide to buy stocks on your own, you will have more control over your investing. But as you will also have to devote more time and attention to your investments, it is important to make a realistic assessment of your ability to handle that responsibility.

It takes time and effort to familiarize oneself with the basics of stock investing. You should have a sense of how to analyze a company to be able to arrive at your own independent judgment of its value and how that compares to its current market price. You should certainly be prepared to spend time reviewing your portfolio periodically and if you are a new investor or not disposed to put in that amount of time, and even more during periods of volatility, then you are better off in mutual funds, which are very convenient and generally require less attention. The alternative is to manage your own portfolio of individual stocks and bonds. If you do not have the knowledge, experience or inclination then this is may not be a good idea.

It is very tempting to listen to all the rumours and noise out there and appear to be selecting stocks; if you are going to buy based on a friend’s hunch about which are the “best” stocks and which are the ones to avoid, and substitute their judgment for yours, then you are probably better off sticking to mutual funds.

Do you have enough money to be able to create a diversified portfolio? How much do you have to invest? Mutual funds offer a clear opportunity for smaller investors who do not have a lot of money to invest. In Nigeria there are several funds that offer relatively low initial investments of N10,000. If you want to build a reasonably diversified portfolio of individual stocks with a reputable fund manager on the other hand, you will usually require a much larger sum.

Mutual funds can reach a wider diversification than can be reached by individual stocks. Dividing up your funds up among a few stocks isn’t usually enough to cushion you against a severe market downturn. By pooling several stocks as an equity fund does, the risk of loss in investing is reduced. If one company or sector performs badly, it tends to be balanced by other companies that may be recording better performance.

By owning a wide variety of stocks across various sectors you reduce your risk of loss. There are different types of mutual funds to choose from including money market funds, bond funds and equity funds to suit different objectives. It is important to note however, that individual stocks tend to have a greater upside potential than most mutual funds; as with all investing, you trade some risk for greater potential reward.

Mutual funds are considered to be among the most liquid investments. As shares in a mutual fund can be bought and sold any business day, it is easy for investors to have access to their money, as the fund is always available to buy its own shares. When you invest in individual stocks, you have to wait for a broker to find a buyer for your shares; this could take several days or longer particularly if the stock is not widely traded.

Mutual funds and stocks?

For those who would rather let professionals handle things on their behalf, mutual funds are the natural choice. At the other end of the spectrum, are those who may want a greater level of participation with their investing and stocks will be the more attractive alternative.

You do not have to narrow down your choice to one or the other; indeed investing in a mix of both mutual funds and individual stocks appears to be a good compromise for the majority of investors.

The overarching consideration must be to adopt a long-term investment strategy and to ensure that a diversified portfolio is built with clear financial goals and objectives in mind.

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