The blog post from 3 days ago prompted this question: At what point in investing would you branch from a mutual fund to individual stocks?
Right off the bat I personally see individual stocks as more risky than mutual funds. There's no diversification when you buy one stock, very little even if you buy several stocks in different sectors.
But then there's no return in any mutual fund like the kind you get when you pick a single winning stock and it just skyrockets. When can you afford to take that risk?? In my opinion? When you have enough money to potentially lose.
To be more specific, I think before any young person buys individual stocks they should have the basics covered:
- a stable job
- 3-6 months savings in case of a job-layoff
- a car that is safe & reliable
- a home, whether an apartment, condo or house and basic furniture/kitchen utensils/linens, etc.
- a working budget that covers food, clothes, home heating/cooling, medical care, electricity & water, etc.
- investments being made for retirement
Investing in individual stocks takes a certain amount of homework, as you may have guessing based on 4 articles on that very topic since since June. And I'm not done yet!
The Story of Ben and the Golden Apple
When our son Ben was in high school, we gave him $1,000 to invest on his own. The agreement was if he lost it, then it would be gone, no questions asked. If he made money, then eventually he would need to pay back the initial $1,000 when he could afford to do so, but then the investment would become his 100%. He did some research, then invested all the money in one stock-- Apple. Nine years later, we can clearly see he made a great choice. He still owns his shares, free and clear.
That being said, I would not advise anyone to put all their eggs in one basket.
It is clear that this individual does not want all her eggs in the same basket, and is working on diversifying her assets throughout the living room
If Ben had picked a stock that tanked, the money would be gone (but only if he sold low!! Sometimes these stocks can come back-- which is why we buy and hold!!!). Our 16-year-old son did this as an experiment, but he was not using his own money. It was money given to him with the understanding that he could potentially lose it all. He had a built in safety-net called mom & dad providing the initial investment. You may not have that luxury.
Cindy and the Terrible, Horrible, No Good, Very Sad Investment
In July of 2006, I bought some stock in British Petroleum (BP). I had done some research that said that BP was the only large energy company that was investing in renewable energy, such as solar and wind power. I liked that idea, and decided to buy a few shares. It seemed a solid value company with OK dividends, and that along with BP's corporate interest in environmental energy alternatives inspired me to buy.
Then disaster struck, but not for me. In April of 2010, a BP oil drilling rig in the Gulf of Mexico exploded, killing 11 workers. The explosion also caused a stunning 210,000 gallons of crude oil to be pumped in the sea every day for nearly 3 months. The impact on the sea, its creatures and the shore's wetlands was devastating. This was not the green energy idea I had in mind. It was not what anyone had in mind.
Big surprise-- the stock tanked after this disaster, and I quite honestly was so disgusted that I ever bought BP that I sold it for a little less than half of what I paid for it. To this day, the stock has not recovered. This is a horrible story of an accident of monumental proportion that cost human & animal lives. The horror of this accident is still evident for the animals, wetlands, and people of the Gulf states. The even longer-term environmental consequences of this awful situation are still not known.
Nothing is worth making money at such an expense, even if the stock had returned to its previous value. The moral of this story is to really understand what the company does that you are buying, and realize you could lose some or all of your money when buying any single stock.
Safer Ground
That was intense to write. The loss of a small amount of money was a very minor thing when considering the big picture. Talking about stocks vs mutual funds is a lot lighter topic.
When it comes to money, you should have a feel for what you can truly afford to lose. It's harder to lose your investment in a solid mutual fund for the simple reason that if one stock isn't progressing within a mutual fund, usually there are plenty of others doing well to offset the loss.
This illustrates members of a diverse grouping, where one individual is going in a different direction than the rest. Overall, however, the majority of the group is aiming in the right direction to offset this individual's decision
It would be nice to have a crystal ball to know single stocks to pick. That's where all the stock picking guidelines come into play.
Choosing mutual funds has its own homework involved, and money can be lost or gained investing in these as well. Anyway, the reader's question assumes that mutual funds are an investor's first type of investment. And they probably should be. With that in mind--
Start early and take advantage of your employer's 401K plan!
First and foremost: Any young person starting out should be investing through their employer's 401K program. Actually, anyone with a job that offers a 401K-- regardless of age-- should be doing this. The choices in 401Ks are usually mutual funds, money market accounts (a money parking lot), and annuities.
This money will be invested before you see your paycheck, so you can't spend it. (You may miss it, but that's another story entirely.) It has the built-in benefit of lowering the taxable income on your tax return. This saves you even MORE money. The money invested in a 401K will grow over decades, and is also tax-free until accessed in retirement.
Many employers will match your investment amount or make a smaller contribution. That's an added bonus for your future. At the point of retirement when you start making withdrawals of this money, these investments will be taxed at a lower rate because you'll have no salary.
No 401k at your job?? Invest in IRAs (individual retirement accounts). This involves a whole other topic, and while not irrelevant, it deserves its own special blog entry. So I'll continue on.
Mutual Funds
Mutual funds are a wonderful choice for anyone saving over a span of years for retirement, a home, a wedding, college funds, the trip of a lifetime, a car-- well, you get the picture. They are comprised of a specially selected group of stocks and/or bonds. Some even offer the simple no-thought-required beauty of built-in diversification (like 'all-in-one' funds).
Mutual funds comprised of stocks come in all varieties-- large company, small company, and mid-sized companies. They may be growth or value based, and have a wide range of risk levels to choose from. So if you are adventurous, conservative or somewhere in-between, there are choices out there for you.
Mutual funds are managed by the people who put them together. These people are paid a certain percentage to manage the mutual fund. There is usually not an upfront fee for buying a mutual fund unless it is a loaded fund. Loaded means that you pay before the investment is ever made, and you still pay the percentage over time. It's like double billing the customer. I do not ever recommend buying loaded mutual funds.
If you sell some mutual funds before a given time frame (such as 6 months, often), there may be a service charge. The people who manage these funds want them to remain as stable as possible.
Individual Stocks vs Mutual Funds
With individual stocks, the fees are different. The fees associated with stocks involve buying and selling (usually around $7-$10 per trade). Buying individual stocks offers more flexibility of how much money you can to invest. If you have $500, you can open an eTrade brokerage account. But good luck trying to find a mutual fund without at least a $1,000 minimum.* People with less cash on hand need to save up in a money market or savings account before investing in mutual funds.
You can hire a financial managers to assist you in picking stocks and mutual funds. Some are wonderful and worth every cent; others not so much. The point of my blog is to help people make their own decisions without involving a middle-man. But this approach is not for everybody.
*But!! The 401k Saves the Day!
These rules change when you are investing in a 401K. Because you're investing with a group of people at your workplace, minimum investment amounts don't apply when buying mutual funds. So you can start off even with a small amount of money.
I believe mutual funds are where anyone starting out should invest. And when your employer offers you a 401K, sign up as fast as you can.
Taxes associated with both mutual funds (unless invested in a 401k or IRA) and individual stocks are a given. Sorry. I could go off on that tangent, but it's probably best to say good bye for now!