For a majority of people, mutual funds should be a major part of their investment portfolio–unless they have a lot of money and ample time to devote to investing in individual securities. While there are arguments for buying stocks and bonds directly, consider buying mutual funds first, or at least use them as a core holding, because of the following drawbacks to individual stock and bond picking and trading:
- First, a great deal of time and expertise is required to analyze a company—its prospects for earnings growth, its performance over the short and long term in comparsion to its competitors, its debt level and creditworthiness, its new products in the pipeline, and technological changes looming that might harm or improve business.
- Second, purchasing individual securities involves higher transaction costs. Even when you use a discount broker, the commissions you pay to buy and sell are not cheap. (However, the cost of online trading is getting lower every year—See Unit 9.)
- Third, owning individual stocks means you are less likely to have proper diversification. To diversify a stock portfolio, you need to own at least 10 to 20 different companies in different industries, which could cost thousands of dollars. For the same price you might pay for 100 shares of one security, you can buy shares in a fund that owns 100 securities. Diversification lowers your investment risk—if one or two stocks plunge, others may gain in value, offsetting the loss.
Nevertheless, there are several circumstances when you do not need mutual funds:
- If you are adept at picking individual stocks
- If you have at least $20,000-50,000 to buy at least 10 to 20 stocks (depending on stock prices)
- You plan to invest in Treasury bills or notes.
In the last case, you would do better purchasing them directly through the Federal Reserve’s Treasury Direct program http://www.treasurydirect.gov/indiv/products/products.htm.