To a man with a hammer, every problem looks like a nail.
For the last few years, investors with goals were like men with hammers: Every answer could be found in mutual funds.
That revolution made funds as ubiquitous as, say, shampoo. Everyone, it seems, has a favorite variety or two that does the job for them.
But now there appears to be a turning of the tide. After several years when mutual funds were billed as the only kind of investment you will ever need, many people appear to be returning to individual stocks.
There are no statistics to back this up, just empirical evidence ranging from financial advisers who say clients have more interest in individual stock purchases to financial publications pushing the idea of direct-purchase stocks.
Whether this trend is a good one, and whether you want to participate, depends more on personal philosophy than anything else. An individual investor can, indeed, be comfortably invested in mutual funds for a lifetime, but may be drawn to the allure and mystique of stocks.
Experts say there is nothing wrong with pursuing individual stocks, but stress that it’s not for the weak-hearted.
“If you are buying stocks because you understand what you are doing, that’s one thing,” says William G. Markos, president of Ipswich Investment Management. “But if you are confident that you can pick a winner just because it seems that everything has been a winner for the last few years, then you are overconfident and you’re going to make some big mistakes.”
The swinging pendulum of investor sentiment toward individual stocks is hardly surprising, especially considering that stocks serve a different purpose in an investment portfolio today than they did two or three decades ago.
Back then, stocks were selected on the advice of a brother-in-law or some tipster, much the way a novice picks horses at the racetrack. Even among professional investors, there was little focus on building a portfolio.
Today, mutual funds have become the common investment, spurred by the development of employer-sponsored, worker-directed retirement plans, where an individual is responsible for making the savings decisions for his or her future.
Funds, effectively, became financial training wheels. As investors became more sophisticated, they bought more advanced types of funds. The industry created thousands of new offerings, many of them highly specialized, and kept priming the pump by reminding investors that a small amount of money delivered a diversified portfolio run by a professional manager.
Financial advisers warned many investors against picking stocks, using the argument that “even if you know when to buy in, you don’t know when to sell,” the latter supposedly being half the equation with individual stocks.
Funds also were an easy investment, often sold at no cost to the investor. For the most part, there is no need to physically hold or transfer shares, small investments are possible, regular electronic withdrawals from bank accounts are encouraged and commissions can be avoided.
And funds introduced many people to the idea that investing can be fun. And if funds are fun, stocks should be, too.
Lo and behold, the people who market individual stocks caught on to these concepts, too. Today, there are more than 300 stocks sold directly to the public by the issuer; the shares are traded in the exact same way as mutual fund shares, often with the same kinds of statements, telephone redemption privileges and more.
“The fund industry convinced people to make investments through the mail,” says Charles Carlson, editor of the “No-Load Stock Investor” and “The DRIP Investor,” two newsletters dedicated to the direct purchase of stock. “Stock (issuers) picked up on that. It has never been easier to invest in quality, big-name stocks than it is right now, and that trend will continue.”
Even some prominent companies have contributed to this blurring of the lines, making stocks seem like funds.
Two years ago, Coca-Cola Corp. compared its multinational operations to those of a global mutual fund. “The more uncertain the times, the more you hear the old saying, `Don’t put all your eggs in one basket,’ ” Coke chairman Roberto C. Goizueta wrote. “Your Company not only has an abundance of `eggs,’ but an abundance of `baskets.’ “
Throw in the idea that many individual stocks have outperformed the market while most mutual funds haven’t, and there are a lot of investors rethinking their take on stocks.
The “you-don’t-know-when-to-sell” argument is moot if you buy brand-name stocks intending to hold them for a lifetime.
“People initially go to funds because they are told it will make investing easier and less complex,” says James P. Owen, managing director at NWQ Investment Management in Los Angeles. “Then they get into it and find out it’s not true. The mutual fund world is as complex as stocks. The difference is what happens when you make a mistake. A bad fund is not very likely to crash; with a stock, that’s a more real possibility.”
Adding individual stocks to a portfolio, therefore, becomes a personal decision based on risk tolerance. While most experts suggest holding mutual funds that invest in the stock market for retirement and college savings, individual stocks have a place in a portfolio for the investor who wants to do the work.
There are many people who believe it can be easier to select one stock than one fund. With stocks, you can examine the product and appreciate its potential–whether it sells computers, hamburgers or electric power.
With mutual funds, you buy a philosophy. The portfolio you see in fund paperwork may already be gone by the time the statement hits your mailbox, so you are buying something a little less tangible.
But while it can be easier to pick one stock than one fund, it’s a lot harder to pick 10 stocks–about what you need to call a portfolio diversified.
If you are a fund investor about to plunge into individual stocks, first do some soul-searching. If you don’t do a lot of research before picking funds, don’t kid yourself into thinking you are a stock picker.
Buying stocks is not just about getting good advice, it’s about knowing enough to determine which suggestions are good.
Next, protect yourself. Most financial experts say that sector mutual funds should account for no more than 15 to 20 percent of an investor’s portfolio. Consider individual stocks a substitute for that part of your holdings. Stock-picking looks easy when the market is rising, but it can be awfully tough when things head south.
Lastly, buy what you know.
Hey, if that axiom was good enough for Peter Lynch, whose performance at Fidelity Magellan almost singlehandedly turned the world onto mutual funds, it’s good enough for the rest of us. Leave the businesses, sectors and countries that you do not understand to the mutual fund portion of your investments.
“In the 1960s, people bought stocks, not funds,” says Don Phillips, president at Morningstar Inc. “In the ’80s, it turned around and everyone gave up buying stocks on their own. There is room for both investments in a portfolio.”
