Evaluating Securities Investments
Mutual Funds vs Stock
Risk is an inherent and unavoidable part of investing. Without risk there would be no payoff to investing. However, the potential to lose your investment dollars always looms large. You have to diversify your investments in order to lessen the chances of your collective investments declining in value. Diversification means not "putting all your eggs in one basket", as they say. Choose a variety of investment vehicles for your portfolio. There is always some portion of the market doing well when everything else is performing poorly.
Many people invest in mutual funds, because their investment strategy is focused on diversification. Spreading risk over different types of investments will help reduce the overall volatility in your portfolio. Investing solely in individual stocks can be very risky. If the companies you invest in do poorly, you will be hurt financially. Additionally, most people are not good at deciding which companies are good investments because they invest emotionally rather than rationally. They make decisions based on how they feel about a stock, rather than by considering that stock's performance statistics. Then, if the company does not perform well, they sell the stock, sometimes prematurely. Investing works best when it is a dispassionate endeavor as free from emotional decision making as you can make it. You have to make choices for the long-term and ride out the ups and downs of the market. This is why many financial professionals recommend mutual funds. More than most people, fund managers are qualified to choose stocks, and able to respond to changing market conditions even-handedly. But, most many mutual funds are managed, so there are fees to own them. You will want to consult a qualified professional to help you decide which investments are best for your needs.
While all mutual funds offer the advantage of diversification, managed mutual funds (as opposed to index funds) have another advantage in the person of the fund manager or managers. You can evaluate the performance track record of the fund manager (or managers if there is more than one) to get a handle on how funds they manage might perform.
A fund manager is a professional whose job it is to manage mutual funds and ensure that they meet each fund's predetermined objectives. That is, the fund manager decides where and when to invest the money controlled by the fund. The fund manager is very important since she or he is tasked with making the investing decisions for the fund and is held responsible for the success or failure of the fund. The manager needs has to have both vision and a sound investment philosophy in order to perform well.
The most desirable fund managers have a proven track record. Though past performance is never a guarantee of future performance, it is generally all you have to go on when making decisions about the quality of a fund manager. You want a fund manager who has a history of good performance; who has consistently exceeded the returns that (unmanaged) index funds can provide.
Another desirable quality in a fund manager is stability. Look for managers who have been with a particular fund for five years or more. Every fund has its peculiarities. You want to buy into a fund where the manager is well-versed in those peculiarities. Beware of funds that that change managers regularly; this is a signal of instability.
Indexed funds don't typically have a fund manager, because there is no need for one to exist. It doesn't take much thought to create an index fund. You simply copy the pattern of stocks that are tracked by the index that forms the basis for your fund. It is important to keep in mind that managed funds don't necessarily do better than index funds. In fact, often the reverse is true; index funds often return better rates than managed funds. You should choose funds based on how they perform, and whether they charge a load or not, not purely on whether they are managed. The advantage of a fund with a manager is solely that when a manager exists, you can look at the manager's past track record to judge how they might do in the future. You can't do this with an index fund, because no manager exists.