By Michael Kalscheur, CFP®
Senior Financial Consultant, Castle Wealth Advisors, LLC
Today, mutual funds dominate the investment world. Everywhere you look there are advertisements about this fund’s performance history or that fund manager’s great tenure. Morningstar trumpets their “Manager of the Year.” This is no small feat, as there are currently 25,027 mutual funds in their database. Add in unit investment trusts, exchange traded funds, variable annuities and separate account money managers and you have over 100,000 options. This compares to about 11,000 domestic stocks that Morningstar tracks.
Most people are familiar with mutual funds through their retirement account. There are usually about 5 – 15 different funds to choose from, many of which focus on different parts of the stock and bond markets. Plans may have actively managed funds, index funds and even target-date funds that rebalance between stocks and bonds as you get closer to retirement. Most of the time, individual stocks are not even an investment option in most retirement plans.
So why even bother with individual stocks? First, a group of well chosen individual stocks can give you exposure to the market without increasing your overall risk. Statistics have shown that you can significantly reduce unsystematic (non-market) risk by holding as few as 20 stocks. However, most people own both mutual funds and individual stocks. If this is the case, the funds will provide the diversification and you can supplement with individual stocks. Just be sure to keep an eye on the overall portfolio. Having a portfolio of equal parts Apple, Google and a technology fund is not diversified.
Second, you may be able to add value that money managers can’t. For example, what if a company comes out with a new product that you use in your professional life? You use it and see that it is better than all the other products out there. You see the need in the marketplace and can envision how this company will do well. This isn’t inside information, but it is knowledge that you have that could translate into better investing. There is a reason why the old saying goes “Invest in what you know.”
Third, you don’t pay an expense ratio on individual stock. Every mutual fund, even index funds, has an expense ratio. Year in, year out, you must pay these expenses. Sometimes the managers pay for themselves by beating the index, sometimes they don’t, but you still pay the fee no matter what. On the other hand, with individual stocks you pay a transaction fee once to get in and once to get out. With the advent of internet trading, you can reduce these fees to less than $10 per trade. That means today, most people can afford to diversify with individual stocks.
Finally, with individual stocks you see the companies that you are invested in. While you can own Exxon, Disney and Eli Lilly through a mutual fund, there is something different when you hold the annual report in your hands. This is especially useful when teaching children about investing. When they can see pictures of what the company does or builds and read the letter from the company’s president about the exciting vision of the future, it gets them excited to invest.
Be advised, investing in individual stocks is not all roses. You must be willing to take on some extra responsibility. It takes extra time and effort to invest in individual stocks. That means reading the annual report, keeping up-to-date on what the company is doing and not selling the stock because of temporary price declines. If you don’t have the time, or if you don’t enjoy doing this “homework,” be honest with yourself and stick with mutual funds, which require much less maintenance.
Another benefit of mutual funds is that they give you access to a team of investment professionals who might have insight into companies that you don’t. While you may be able to find out plenty of information on Exxon, what about smaller companies? What about companies in France, Brazil or Korea? What about bonds? You only have so much time for research, so pick which things you want to focus on. If you can’t focus on international small companies, then hire a mutual fund to do the work for you.
Regardless of whether you invest in individual stocks or mutual funds, it’s also very important to find a professional advisor who can offer ideas and recommendations. Their job should be to look at the big picture, your overall investment allocation, and keep your risks in line with your goals. Whether they meet with you once a year or manage your investments on a daily basis, having someone on your team that knows you and your family provides an important level of security and protection.
In short, investing in individual stocks can be just as rewarding as investing in mutual funds if done right. Who knows where it might lead you. Your individual stock picking might make you the next Grace Groner, the woman who purchased just 3 shares of Abbot Laboratories in 1935 and turned a $180 investment into $7 Million.
Michael Kalscheur, CFP®, is a Senior Financial Consultant at Castle Wealth Advisors, LLC. Castle specializes in helping families and closely-held business owners with strategies to protect and transition family assets from one generation to the next. Castle’s senior partners also work with clients throughout the country in making logical decisions to help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or contact Michael directly at .