Mutual Funds v. Stocks
12-14-2006, 07:20 AM
#1
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Mutual Funds v. Stocks
Before you decide whether to invest in a Mutual Fund or in Stocks the beginning investor needs to understand what a Mutual Fund is.
A Mutual Fund is a portfolio of stocks, bonds and other assets managed by a fund manager. Each fund is designed with a particular goal in mind. That goal may be to invest in global companies (global funds), emerging markets (China, India, Brazil, Russia or other 2nd world companies) or in sector diversified stocks (balanced). They may be designed for income (value) and invest in slow or no growth companies which pay dividends or for growth and invest in high growth companies which pay little or no dividend and provide little or no income.
The goals of a fund are laid out in their prospectus and reading and understanding it is essential. If you don't you may find yourself investing in garbage you would never choose to buy on your own.
Step 1: Know Yourself and your Goals
Before you look at funds you need to figure out what your goals are as an investor. Nobody can tell you what those are, they come from you alone. If you are young you'll probably want growth and are prepared to take more risks in search of higher rewards. If you are older, say in your 50s you'll start moving yourself toward lower risk investments as you won't be able to afford to give up the gains you've made. Once you hit 60 or older you are going to be able to tolerate almost no risk as you can't exactly go out or have the time to make back big losses.
Decide where you fit in the risk rainbow and how much risk you are prepared to handle. What sort of returns are you looking for? 1000%, 100%, 20%, 5%?
Step 2: Know how Hand's On you want to be
If you just want to make a monthly or weekly deposit and get a quarterly statement saying how well you did or didn't do then simply find a fund which matches your goals above and buy it. You can setup an automatic transfer to buy more of your fund periodically and to have any income generated reinvested in the fund.
If you are prepared to put in some of the work the fund manager does like reading the news, keeping up with analyst reports, watching the stock values and generally stay on top of things (Jim Cramer says it takes 1 hour per week per stock) then you can probably manage your own portfolio and buy and sell individual stocks. You need to stay on top of it though and if you aren't prepared to or don't want to do the work then you should hand it to someone who will.
Step 3: Know how much you have to Invest
If you have less than $5000 to invest, perhaps even $10000 then you should strongly consider a Mutual Fund rather than stocks. You don't have enough to build a diversified portfolio and are open to significant risk. If you can tolerate that and want to make money quickly then be prepared to gamble a bit.
If you have more than $10000 to invest you can more than likely build your own portfolio better suited to your goals than a fund manager can but only if you are prepared to do Step 2.
One Fund or Multiple Funds
I recommend only choosing a single Mutual Fund. If you are in more than one fund you are putting in just as much work if not more than managing your own portfolio. Because we can be talking about hundreds of holdings within multiple funds it can get very tricky to understand exactly what you are invested in.
If you want simplicity find a good fitting Fund and buy it. If you want to manage your portfolio more closely don't buy more than one fund, build your own portfolio.
A Mutual Fund is a portfolio of stocks, bonds and other assets managed by a fund manager. Each fund is designed with a particular goal in mind. That goal may be to invest in global companies (global funds), emerging markets (China, India, Brazil, Russia or other 2nd world companies) or in sector diversified stocks (balanced). They may be designed for income (value) and invest in slow or no growth companies which pay dividends or for growth and invest in high growth companies which pay little or no dividend and provide little or no income.
The goals of a fund are laid out in their prospectus and reading and understanding it is essential. If you don't you may find yourself investing in garbage you would never choose to buy on your own.
Step 1: Know Yourself and your Goals
Before you look at funds you need to figure out what your goals are as an investor. Nobody can tell you what those are, they come from you alone. If you are young you'll probably want growth and are prepared to take more risks in search of higher rewards. If you are older, say in your 50s you'll start moving yourself toward lower risk investments as you won't be able to afford to give up the gains you've made. Once you hit 60 or older you are going to be able to tolerate almost no risk as you can't exactly go out or have the time to make back big losses.
Decide where you fit in the risk rainbow and how much risk you are prepared to handle. What sort of returns are you looking for? 1000%, 100%, 20%, 5%?
Step 2: Know how Hand's On you want to be
If you just want to make a monthly or weekly deposit and get a quarterly statement saying how well you did or didn't do then simply find a fund which matches your goals above and buy it. You can setup an automatic transfer to buy more of your fund periodically and to have any income generated reinvested in the fund.
If you are prepared to put in some of the work the fund manager does like reading the news, keeping up with analyst reports, watching the stock values and generally stay on top of things (Jim Cramer says it takes 1 hour per week per stock) then you can probably manage your own portfolio and buy and sell individual stocks. You need to stay on top of it though and if you aren't prepared to or don't want to do the work then you should hand it to someone who will.
Step 3: Know how much you have to Invest
If you have less than $5000 to invest, perhaps even $10000 then you should strongly consider a Mutual Fund rather than stocks. You don't have enough to build a diversified portfolio and are open to significant risk. If you can tolerate that and want to make money quickly then be prepared to gamble a bit.
If you have more than $10000 to invest you can more than likely build your own portfolio better suited to your goals than a fund manager can but only if you are prepared to do Step 2.
One Fund or Multiple Funds
I recommend only choosing a single Mutual Fund. If you are in more than one fund you are putting in just as much work if not more than managing your own portfolio. Because we can be talking about hundreds of holdings within multiple funds it can get very tricky to understand exactly what you are invested in.
If you want simplicity find a good fitting Fund and buy it. If you want to manage your portfolio more closely don't buy more than one fund, build your own portfolio.
12-14-2006, 07:56 AM
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Note, too, that the diversity of types of mutual funds equals (or surpasses) that of individual securities. There are stock funds, bond funds, real estate funds, commodity funds, and so on. And within each category there are varieties galore: a bond fund could be a short-term government fund, a high-grade corporate fund, a fixed-rate mortgage fund; the list goes on.
As mentioned above, the key to investing in mutual funds is understanding the characteristics of the primary type of investment they hold. That understanding is your responsibility.
As mentioned above, the key to investing in mutual funds is understanding the characteristics of the primary type of investment they hold. That understanding is your responsibility.
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12-14-2006, 03:31 PM
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Mutual funds are great, but if you know what you are doing, you can construct a no-risk portfolio based on the relationship of the stock prices in relation to known events. (Gold vs. equities for example move oppositely to certain market conditions). With the right mix, you can construct a portfolio with a standard deviation of the rate of return effectively nullified by diversification, while retaining their average RoR.
If you can determine the "efficient frontier", any stock beyond that line should yield above average returns when compared to the market as a whole, while exposing the investments to lower overall risk.
Efficient Frontier Theory
John
If you can determine the "efficient frontier", any stock beyond that line should yield above average returns when compared to the market as a whole, while exposing the investments to lower overall risk.
Efficient Frontier Theory
John
12-14-2006, 05:49 PM
#10
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John you had me right up to the "no-risk" part at which point your credibility went in the toilet. I'm sure you were just being enthusiastic and didn't actually mean that your strategy was a sure bet 100% of the time.