With all the financial and money programs on TV talking about stocks, how do you know which ones to have in your portfolio? There are two main options to think about when making these choices; purchasing individual stocks or purchasing mutual funds.
Individual stocks can be bought by any investor through a brokerage, and it becomes the responsibility of the individual investor to maintain their own portfolio. Mutual funds come in two basic types; actively managed and passively managed, called index funds. Mutual funds are widely regarded as a lower risk form of investing, while investing in individual stocks is a more active, riskier form. Both carry inherent advantages and risks, and it is important for you to understand the differences between them.
Actively managed mutual funds are baskets of stocks, which try to beat the market with the assistance of a fund manager. An index fund is a type of mutual fund whose primary investment objective is to mimic the performance of a specified market index, such as the S&P 500 Index or the Wilshire 5000 Index.
Most beginner investors start with mutual funds, since they are automatically diversified, and present investors with a large variety of flavors – from sector based funds such as tech, financial, retail or energy to commodities or foreign indexes. Mutual funds generally hold a large number of stocks, with each stock only comprising a small percentage of the portfolio. This is both its strength and weakness.
When purchasing mutual funds, investors usually don’t define the exact number of shares to purchase; rather, they request a set dollar amount from a broker, and the broker calculates the number of shares to be purchase based on that day’s closing price.
Each mutual fund has its own set of fees and expenses. These can include, but are not limited to, the fund manager’s fee, called an expense ratio, a front-end load upon initial purchase, a back-end load upon sale, as well as early redemption charges. It is important to understand the complex fees of mutual funds in the prospectus before purchasing any shares, as the purchase equals a binding agreement to pay these extra charges.
For investors who favor mutual funds, one way to avoid the majority of fees, is to use index funds, which are passively managed mutual funds that simply mirror a set market index, such as the S&P 500. This may be a better lower-cost alternative for you. Working with an experienced Certified Financial Planner™ will help you navigate through these fees and avoid most of them.
For the more adventurous investor who is not satisfied with the lower return on mutual or index funds, picking individual stocks for your personal portfolio is the preferred choice. Purchasing individual stocks can be done directly through any broker, with the only fees being the commission paid upon the purchase of the shares and the capital gains tax paid upon their sale. Investors can define the exact amount of shares to purchase, and the desired price. Dividends from individual stocks can also be reinvested into the company.
So, Which is Better for You?
For the average investor, in most cases, mutual funds and specifically index funds, are the best way to go. However, remember to work closely with your financial planner to choose the proper balance of your funds; the most critical part of your portfolio.
By giving us a call at Compass Rose we can help you get your portfolio in order.