Market Beat: Should you buy mutual funds or individual issues?
August 9, 2017
One question I frequently hear from investors is whether they should purchase individual stocks and bonds for their investment portfolio or use mutual funds exclusively.
As usual, when it comes to investments, there is no one-size-fits-all solution. The answer depends on your individual situation, which includes things like age, income, and net worth.
The big advantage of mutual funds is the diversification. One advantage of individual stocks or bonds is that there is no ongoing investment expense after the initial purchase.
Investors with relatively small portfolios should definitely start out by building a portfolio of mutual funds. Those with more funds to invest may want to consider using individual issues also.
Fixed-income investors may prefer having a portfolio composed of individual bonds. That way, they can control their maturities for interest rate risk and have no ongoing expenses.
An investor with $50,000 could build a 10-year bond ladder by placing $5,000 into 10 different bonds with maturities ranging from one to 10 years. I would suggest using investment-grade bonds for a ladder strategy that have very low default risk.
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Mutual funds may be better for high yield or junk bonds because the default risk is much higher with junk bonds and broad diversification can help manage that risk. The default rate for junk bonds has been as high as 40 percent in times of recession.
With individual stocks it will require a larger portfolio to be able to diversify properly. For example say you want to own the stocks that make up the Dow Jones Industrial Average and you had $300,000 to invest. You could buy the Diamond, the exchange-traded fund that represents the Dow or you could put $10 thousand dollars into each of the thirty stocks in the Dow. The expense ratio for the Diamond is 0.017 percent or 17 basis points.
With a $300,000 investment that would cost $510 dollars per year, and the ongoing amount would fluctuate with the value of the portfolio. If you bought the 30 individual stocks, you'd have higher initial transaction costs because you'd have to pay commissions for 30 separate transactions, but then you'd have no ongoing annual expense.
There are advantages and disadvantages to both, and which is better really depends on your individual situation and goals.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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