Many people who invest in individual stocks probably own some mutual funds also.
Mutual funds have some attractive qualities:
- Professional management
- Easier diversification
- Liquidity
- Wide selection
Not all mutual funds have the attributes listed above. Many funds underperform the major market index - the S&P 500.
Some mutual funds carry high fees and onerous withdrawal penalties. Some funds give a false sense of diversification, but their portfolios contain similar enough stocks that a turn in the economy can be a disaster.
If you are careful, it is possible to find funds with low costs (one of the major determinants of fund profits), good managers and true diversification.
If you participate in a sponsored retirement plan such as a 401(k), you most likely have a selection of funds to choose from.
So, why would an investor want to buy individual shares of stock?
There are several good reasons and some bad ones.
Investing in individual shares is often less expensive than paying mutual fund fees. There is no cost beyond the broker's fees when you buy and when you sell.
With low-cost online brokers, this expense is minimal. Mutual fund holders pay fees whether they sell or not.
Both mutual fund owners and owners of individual shares of stock may have tax liabilities. In fact, mutual fund holders may face more taxes depending on the fund.
If investors do their homework, purchasing individual shares of stock carries only as much risk as the investors are willing to bear.
Poor choices will result in a disappointing outcome regardless of whether the investor buys mutual funds or individual stocks.
In the end, most investors are better off owning both mutual funds and individual stocks.
A few good mutual funds will help investors with the diversification that offers some protection during swings in the economy.
A select choice of individual stocks offers more potential for gain, while keeping risk within reasonable limits.
Advice that you should only own stocks or only own mutual funds is misguided.
Ask questions and question assumptions.
