We probably all know someone who was just learning how to start investing, and in the process he bought a hot stock. That stock skyrocketed through the roof, and now everyone you know is trying to get a share in that stock.
However, for every stock investing success story, you’re likely to find a hundred who lost BIG TIME. For most new investors, mutual fund investing is a much better route than single stock investing.
What is a mutual fund?
A mutual fund is a group of investors who pool their money and purchase investment items according to the prospectus of the fund. John might send $100, Steve might send $500, and Sally might oversee that $600 on behalf of the investors. Sally cannot do whatever she wants with the money, but she must invest it according to the fund goals (prospectus).
Reasons Why Mutual Fund Investing is Better than Single Stock Investing
1. Mutual fund investing reduces investment risk.
When you buy a single stock, your entire investment depends on the success of that stock. However, when you buy a mutual fund, you are buying a dozen or a hundred stocks in a single purchase. Thus, if one stock goes down, it is possible that another one will go up.
In the investment world this is called diversity, and spreading your risk out is always a good idea.
2. Mutual fund investing carries less emotional risk.
When you’re investing in single stock, your money is not the only thing you risk. You also risk your emotions. Think about it. What would happen if one day your stock shot up 34%, and then the next day it dropped 32%? Wouldn’t you be kicking yourself for not selling? Wouldn’t you be wondering if you should sell or buy more?
Because of the diversity a mutual fund, it might increase in value by 1% over a two day period. That is nothing glamorous, but it provides a lot more emotional peace.
3. You can buy more diversity for less money.
If you wanted to buy 25 different single stocks, you’d probably want to have at least $1,000 just to make up for all the investing fees. Even if you have an online discount stock broker, you’ll still pay at least $5 per trade. That adds up over 25 stocks.
However, you may be able to purchase just one mutual fund that holds 25 different stocks. As long as you have the minimum requirement, you only pay the transaction fee for buying one mutual fund instead of 25 stocks.
4. Mutual funds have full-time money managers.
Unless you live full-time in the investment world, you probably don’t keep up with all of the factors that influence and affect market change. Now, let me be clear. Even a professional cannot predict what will happen in the future in terms of investments. However, based on the recent history, a money manager can make decisions that will help you increase the value of your investment. If you are going to deal in stocks, you might want to invest in mutual funds so at least there is a team of people managing your money (instead of me, myself, and I).
5. Mutual funds send you an annual report for tax purposes.
If you have a mutual fund, you won’t need to track capital gains and losses. All that will be done by the mutual fund company. This obviously is a less complex system that requires less work. Still, it is important to know about how mutual fund capital gains differ from stock capital gains because with a mutual fund you have gains even when you don’t sell your mutual fund.
6. Mutual fund management is regulated by the government.
There are accountability checks and balances in place to be sure that mutual fund companies administer their funds in line with their prospectus. The Security and Exchange Commission regulates all things mutual fund.
If you are a new investor and you’re thinking about getting into single stock trading to see if you might be the next person to pick a winning stock, then I’d advise you to seriously consider the advantages of a mutual fund.
This article was written by Craig Ford, a freelance writer and missionary in Papua New Guinea, writes at MoneyHelpforChristians.com.