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Thursday, July 22, 2010

Invest in Individual Stock or Mutual Fund?

Many people just assume that mutual funds are the best way to save, but like most "conventional wisdom," it's often wrong.

Conventional wisdom will tell you to put your money in a mutual fund. Well, conventional wisdom does not apply in the stock market. Today, there are more mutual funds with various schemes than there are stocks to buy from the stock indices. A mutual fund can be your worst investment decision.

There is an enormous amount of money being put into mutual funds every year. These so-called "safe" investments have been consistently under performing the markets over the years.

That's right, when the market goes up 40%, your mutual fund probably returned 25%. What happens when the market goes down? And believe us, it does go down! If the market is down 20%, your fund will probably be down 30% and you lose both ways.

If there are almost more mutual funds than there are stocks, then how do you pick a mutual fund?

Do you need a mutual fund that helps you pick a mutual fund? Sounds silly, doesn't it? Guess what, they already exist. There are mutual funds that take your money and pick different mutual funds to invest in.

With all the free information available today, you're better off picking the stocks yourself. You would save yourself a lot of money.

You can dramatically reduce your investment expenses by cautiously selecting your individual stocks, and minimizing the number of your trades. The average mutual fund has fees and expenses of over 1.00% per year for the privilege of underperforming the market. Between 85% and 95% of mutual fund managers underperform the indices, depending on who's doing the counting.

One of the big advantages of mutual funds is diversification. Your mutual fund manager pools your money with thousands of other people and builds a portfolio containing hundreds of securities representing companies in dozens of industries.

Unfortunately, too much diversification isn't good for you. You don't need to hold hundreds of securities to be properly diversified. Increasing the number of securities held does reduce your risk, but the reduction becomes negligible once the portfolio reaches 20 or 25 securities, spread across several industries.

If you need only 25 securities to be completely diversified, why is your fund manager holding 200 securities in your mutual fund?

He can't buy enough stock in the companies he likes, so he has to add second and third rate issues to remain fully invested. Even if your mutual fund manager is a bona fide genius, it's unlikely he has more than 5 or 6 good investment ideas a year. You want your mutual fund manager's best ideas, not the 200 mediocre ones.

Once a mutual fund gets too large, the manager has to buy large capitalization stocks for liquidity. Also there are restrictions on how much of any one stock they can hold.

So, how do you decide what stocks to buy?

People have many different ways to pick stocks. Some people will only look at companies which have good earnings and sound fundamentals.

Others will look at the core of the business and determine if the products or services offered is better than it's competitors or they might only look at the charts of stocks and try to determine if the stock is going higher or lower.

Many might even not look at anything and just get in and get out of stocks in matter of seconds.

Do you think that you don't have time to become an amateur securities analyst?

In such a case stock picking answer is really simple:

Just listen to equity analysts and evaluate their stock research and investment ideas in terms of company background, past performance, management views, dividend payments & risk involvement. Check your risk factor and accordingly break up your stock investments by investing in Small, Mid & Large cap stocks.