As a finale to mutual fund week, I wanted to share my thoughts on the continual debate between mutual funds (especially index funds) and individual stock picking. There are both positives and negatives to each and I hope not to sway you too strongly in one direction or another, because each have their proponents (for instance, just read . So let’s look at some of the major benefits and drawbacks of each strategy side by side.
Individual stock picking allows for massive and quick returns. If you invest in individual stocks, you give yourself the opportunity to pick the next Starbucks and ride all the way to the top, doubling or tripling your investment annually. This is simply not going to happen in a mutual fund.
Mutual funds hedge you against massive and quick failures. On the other hand, your individual pick might be the next Enron, which would mean bankruptcy. Investment in a mutual fund leverages this risk because you’re invested in a lot of companies.
Individual stock picking requires a lot of homework for success. Jim Cramer recommends one hour of research per week per individual stock holding, and I think that’s a pretty sound prescription if you want to see big successes.
Mutual funds require little research, but detach you from the day to day mechanics. With a mutual fund, it’s easy to get in, but it’s hard to really have a pulse on what’s going on with your investment. With an individual stock, you can just obsessively follow a certain company; with a mutual fund, it’s too broad to follow, so you just have to trust the fund manager.
Individual stock picking costs you on the buy-in and the sell with brokerage fees, but leave you alone once you’re invested. Thus, many small trades can eat you alive just with the fees, let alone the capital gains taxes. However, if you plan your moves carefully and have some strong money to invest, the fees become quite tiny in comparison.
Mutual funds generally cost nothing extra to get in, but slowly sip away expenses over time. Again, some careful planning can minimize this drain – get into an index fund that has a very low expense ratio.
So, which is better? Individual stocks are generally high-risk and high-reward but they require some serious footwork. Mutual funds generally have lower risk and don’t require as much homework, but they won’t get you rich in a few years. As for me? Mutual funds are the foundation; individual stocks are things to play with.