Oh, what one would give for a crystal ball right about now. Who wouldn't want to take a look into the future of national politics, the global economy and weather patterns in order to formulate a sound investment strategy. But crystal balls are that of fairy tales, so the small investor's best hope is still a clear understanding of personal investment goals and the advice of a trusted, competent financial planner.
In considering whether to buy individual stocks and bonds or mutual funds, the question is not which is better, but whom you want to control your money, says Craig Schermerhorn, managing director of Benjamin F. Edwards & Co. "Both are attractive variations on the same theme."
Buying individual stocks and bonds gives you direct ownership in a company and complete control of the purchases, Schermerhorn says. Buying equity mutual funds is passive ownership, ceding control of purchases to another entity, which decides what to buy, when to buy and when to sell on your behalf.
"Most of my customers have both," Schermerhorn says. "There is nothing more cost-effective -- and often better-performing -- than individual blue chip or utility stocks. You buy them and may own them for five, 10 or 20 years, and during that ownership, after the cost to acquire them, there are no more fees. It's free from that point on. The benefits of ownership come to you without the middle man taking out costs."
Schermerhorn continues: "It can also be a very educational thing to own individual stocks. You are involved directly in American capitalism. You can learn about the companies you study, and most importantly for a lot of people, you can tailor your ownership to stocks you like or dislike. The hope is that you can put together a good portfolio that will make you some money and bring a smile to your face at the same time. That's much more difficult to do with mutual funds."
"The biggest issues I think it boils down to are how much time people want to invest and how much risk they can tolerate," says Brian Barstead, certified financial planner and practitioner with Ameriprise. "It's hard for people without a lot of money to be diversified enough so that if one stock loses money, something else is making money."
Diversifying helps manage the various types of risk when you buy an investment -- economy risk, when just about all business is down; sector risk, which is industry-specific; and company risk, which can be influenced by personnel issues, product and marketplace changes, and more. Buying a mutual fund allows you to diversify across all the kinds of risk, getting you a few shares of many companies, some of which may experience downturns while others are turning up.
Barstead notes that for the high net worth investor, however, even losses can have a benefit. "Clunkers can be recorded as a loss on your taxes," he says. Talk to your tax adviser about this.
As for bonds, Schermerhorn says, they "bring a different dimension that stocks don't. If you own a bond directly, you own a very certain investment. You know what you paid for it; you know what it's going to pay you each year; and you know when it is going to mature. When you buy a mutual fund comprising bonds, you only know what you paid for it. You don't know for sure what it will pay you, because as they adjust the portfolio, the income will change. And there is no maturity date; there is no natural exit point. You must decide when to sell. And that creates a level of uncertainty, which can be financially harmful in a time of rising interest rates."
Finally, Barstead encourages his clients to examine their investments near the end of the tax year. "This time of year, most people think about whether they want to prune anything out of their portfolios. It's an opportunity to shuffle the deck." Talk with your tax adviser about the most beneficial time to declare any losses or gains, Barstead says, whether in the current or upcoming tax year.
For more information on mutual funds and investing, Barstead recommends visiting http://www.sec.gov/investor. And Schermerhorn notes that "according to Securities and Exchange Commission regulations, anyone considering purchase of a mutual fund must acquire and read the prospectus for that fund."