transaction-make buying less than $1,000 worth of stock generally impractical.
Funds help investors avoid the biggest risk of investing: lack of diversification. Compared to stocks, mutual funds reduce volatility. That is, the investment’s value is not likely to rise or fall as widely as an individual stock’s. This might encourage investors to continue investing, a major key to success.
Another consideration is an investor’s time. Most people are too busy to become stock experts or market gurus. Johnson says mutual funds offer investors the expertise of professional fund managers whose performance record is public information. It’s also easy for investors to keep track of their portfolio, and some mutual funds offer extra amenities, such as money transfers and telephone customer service.
THE CASE FOR STOCKS
In terms of profits, Johnson says individual stocks typically are more volatile than mutual funds, but they also offer greater return potential. He suggests that Bill Gates, founder of Microsoft (Nasdaq: MSFT), would not be as rich as he is today if he had invested his money in mutual funds rather than in his Seattle-based computer software company’s stock.
But there are no guarantees with stocks. Sue Stevens, director of financial planning at Morningstar Associates L.L.C., the registered investment advisory business of Morningstar Inc. (www.morningstar.com), says that during the past year, 351 of the stocks her firm tracks have returned more than 200%. Only one U.S. mutual fund performed as well. But consider this: of the 5,527 mutual funds Morningstar follows, only 16-fewer than 1%-lost more than 20% of their value over the past year. In contrast, of the 7,651 stocks Morningstar follows, 2,514, or 33%, had negative total returns of more than 20%.
Fees and taxes are other factors investors should look at before selecting mutual funds or stocks. The operational expenses of a mutual fund are deducted from its assets, which can significantly reduce the total return. In contrast, stocks don’t carry these costs, which can range from 0.1% to 2% or higher. Greenjungle .com’s Johnson says even no-load mutual funds-those with no upfront costs-have expenses tied to the fund’s marketing efforts as well as management fees.
Another downside: With mutual funds, investors can’t control the timing of capital gains distributions or the taxes on those distributions. Why? It’s up to the fund’s management to decide when to sell and buy stocks within the portfolio. But he also said that there are some funds, including index funds-those tied to the performance of such indices as the Dow Jones industrial average, the Nasdaq, and the Standard & Poor’s 500-that minimize taxable distributions by having less frequent sales of stocks within their portfolios.
Stevens of Morningstar Associates maintains that tax implications are among the strongest reasons investors should consider purchasing individual shares. She says stocks can be used at year-end to cancel out gains elsewhere in your portfolio, and investors can control when they realize gains or losses depending when they decide to sell. But she warned that even with individual stocks, investors should invest for the long haul and avoid such