Should I Invest In Stocks Or Mutual Funds

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Should I Invest In Stocks Or Mutual Funds



Mutual Funds Stocks Author: Admin

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For some investors, buying carefully picked stocks in well-managed, successful companies is a smart choice. As value investors, this route assumes that the important groundwork is done through analysis and comparison, and that the time is taken to understand not only the profit potential, but also the risk.

Buying stocks directly is not the only way to invest; however, many people who start out working with others or focusing on mutual funds eventually learn enough about the market that they feel comfortable buying stocks directly. It’s a matter of personal choice and comfort, not to mention experience. A mutual fund is a conduit investment, meaning the fund’s management handles portfolio decisions for its investors and passes through all profits in the form of dividends, interest, and capital gains. The fund acts as a conduit between the components of the portfolio and each investor.

Investment Clubs

Some novice investors will eventually get to the point where they will feel safe buying stocks directly. However, that prospect can be daunting as well. For these individuals, some alternatives are available and can help not only to ease the apprehension but also provide an education along the way. An investment club is a good place to start.

There are many ways to join or form an investment club. One of the best is to join the National Association of Investors Corporation, which supports over 8,600 investment clubs and has more than 90,000 individual members.

Valuable Resource

The NAIC (www.betterinvesting.org) is an association of individuals belonging to investment clubs. They provide publications, forms, and advice from experts and fellow members.

Most clubs hold monthly meetings and members agree to deposit a fixed amount every month to pool together. At the meeting, the research shared by members is explained and discussed, and when appropriate the members decide which stocks to buy. Most clubs have about 15 members. Once club size moves above 20 or 25, it becomes difficult to keep the organization working smoothly and agree on a course of action.

Key Point

Anyone apprehensive about picking stocks on their own will benefit by looking into investment clubs as a way to pool resources and capital.

A wise starting point is to agree among members and potential members on an investing philosophy and how research is to be shared. Most NAIC members subscribe to a conservative theory and rely almost exclusively on the fundamental analysis of stocks to develop a list of investment candidates. If a club is to take greater risks or speculate in the market, all members should agree; otherwise, this strategy will not be appropriate, especially for those new to investing.

Key Point

Investment clubs work only if all members agree on the investment objective and appropriate risk level.

Investment clubs meet regularly every month, which is a good idea because it allows members to set aside the same time every month to attend meetings, and also lets people know how much time they have to complete their research before the next meeting date. The meeting is often held in a member’s home, a local library, a church hall, or a coffee shop. The agenda for each meeting should be structured well and should include updates on the portfolio’s performance, research presentations by members, a talk by a guest speaker if available, and decisions about whether to invest in any additional stocks. The complete meeting should not exceed two hours at the most.

Since investment clubs pool members’ money, they need to be set up with a formal organization and contract. NAIC provides valuable help in deciding which organizational form to use for an investment club. In addition, club members might want to pick a broker by referral and vote; or they might decide to be completely self-directed and use one of the many online discount brokerages.

Clubs generally need some form of organizational leadership as well. Clubs don’t want to become overly formal, but electing officers and leaders of meetings just makes sense. At the very least, investment clubs need to elect a president or presiding partner, an assistant, a treasurer or financial manager, and a secretary or recorder.

Investment clubs can provide a good starting point for you. The shared research and acquired experience of 15 people is a powerful force, and it helps many people to gain knowledge and experience efficiently and profitably. For many others, mutual funds have been a popular choice for many decades.

Types of Mutual Funds

The mutual fund industry is huge. There are thousands of choices for investors, and many different types of funds. These types are defined by investment objective as well as by the cost to invest. Objectives include growth or income, conservative versus speculative, and even type of investment. Some funds specialize in regions or countries, others in specific sectors or types of companies. Any theme you can imagine has probably been set up and organized in some type of mutual fund. The basic type of mutual fund is an open-end fund, meaning that the fund will accept as many investors and as much money as it can raise, without limitation. So a successful fund is likely to grow over time as a growing number of new people open accounts and send in their dollars. This is the most common and popular type of mutual fund.

Key Point

Mutual funds are so popular that you can find one perfectly suited to your investment objectives.

Compared to the open-end fund, the closed-end fund does place restrictions on the number of shares outstanding. While the open-end fund allows investors to buy and then redeem shares directly with the fund management, a closed-end fund is more like a stock. Shares are traded over a stock exchange and could actually grow in value above the true assets value of the portfolio, if demand for those shares is strong enough based on the fund’s performance There are few closed-end funds available today, and for every closed-end fund, there are more than 13 open-end funds on the market. The newest type of mutual fund is the exchange-traded fund (ETF), which also trades on stock exchanges and contains a preidentified basket of stocks in its portfolio. In 1995, there were only two ETFs; by the end of 2008, there were more than 700 and the number expands rapidly every year. A final broad classification in the mutual fund group is called a unit investment trust (UIT). This is a type of fund that buys bonds and other income-generating securities, pools them together, and then sells shares to investors. A UIT is not actively managed like a traditional mutual fund because the portfolio of income securities is purchased in advance. Payments are made for capital gains, dividends, and interest as these are earned.

Key Point

The ETF as an alternative to the traditional mutual fund makes sense; it is easily traded, management fees are minimal, and the portfolio is picked in advance.

The level of investment in mutual funds, ETFs, and UITs has grown substantially over the years.

The $10 trillion invested at the end of 2008 was owned by more than 93 million U.S. investors, according to the Investment Company Institute (ICI). The growth in mutual fund investing has been impressive.

Valuable Resource

For more statistics and information about mutual funds, check the Investment Company Institute website at www.ici.org, and to see the complete annual Fact Book ICU publishes, go to www.icifactbook.org/pdf/2009_factbook.pdf.

The number of mutual fund companies by type is also interesting.

Mutual Fund Fees

One of the biggest problems with picking a mutual fund is the variety and number of fees that might or might not be involved. The success of mutual fund investing has made it especially complex, and making valid comparisons is difficult. Some fees are hidden; some apply when you sell rather than when you buy; and some are given different names from one fund to another. The range of fees includes the sales load. This fee should apply only when you buy mutual fund shares through a broker or financial planner. As the name says, this is a sales commission paid to the salesperson who recommends a fund to you. A common fee is 8.5 percent, meaning that the minute you invest $100, the load of $8.50 is deducted and given to the salesperson.

Key Point

Making like-kind comparisons among mutual funds is so difficult because the many different fees vary and are given different names.

The fee comes off the top, meaning that only $91.50 of your $100 goes into the investment. The group of funds known as load funds are those that deduct this commission. However, even if you purchase shares directly and without assistance from a financial planner, you might have this sales load deducted. Over history, there has been no trend of load funds outperforming the commission-free funds you can buy on your own, known as no-load funds. A justification for paying a sales load would be that a financial planner has researched and compared all available funds and knows that the fund he or she is recommending is most likely to perform well in the market. This also assumes that the broker or planner has examined the portfolio and investment experience of management and has seen a clear distinction of one fund’s performance over another. These assumptions are not necessarily true. The problem comes down to that commission. A salesperson who is compensated by commission is not going to recommend a no-load fund even if it is likely to outperform a comparable load fund. In addition, you should not assume that the research and comparison of investment value has even been performed before a recommendation is made.

Key Point

If a financial expert is promoting a load fund as your best choice, ask for proof based on recent performance. Paying a sales commission does not ensure that you will be investing in a better choice.

The load is also called a front-end sales load because the commission is deducted right off the top before your capital is invested in shares of the mutual fund. Recognizing how disadvantageous this is, some mutual funds have devised what is called a back-end sales load. This is a fee deducted when you redeem shares so that the sales commission comes out of your accumulated investment plus earnings, rather than being taken before the investment is even made. The back-end load may not be charged at all. In some very popular arrangements, the back-end load is actually called a contingent deferred sales load (CDSL). This is charged only if you redeem shares within a specified period of time. If you hold shares beyond that deadline, the fee will not be assessed. The contingent load may be reduced over a period of years, eventually falling to zero for extended holding periods. A mutual fund calling itself a ‘no-load’ fund will not deduct a sales load, but many do assess other fees given a broad array of names. These include purchase fees, redemption fees, exchange fees, or account fees. None of these are considered sales loads as long as they do not exceed the percentage of the current value of an account. So a fund describing itself as no-load might change fees under a different name.

Key Point

A fund called ‘no-load’ is not always the cheapest to buy; a variety of fees and charges might apply.

redemption fee differs from a back-end sales load in the sense that it is not paid to a salesperson, but is described as covering the cost the fund has to absorb when it redeems your shares. Redemption fees are limited to 2 percent or less of the value of redeemed shares. All mutual funds charge some fees. These include the management fee, which is compensation for the professionals who research companies and make buy and sell decisions in the portfolio.

What are the Different Types of Mutual Funds

There are two additional considerations in the selection of funds. First is how fund shares are valued, and the second is to understand the distinction between different kinds of mutual funds.

You will find daily listings for net asset value (NAV). This is the ending day value of the fund’s entire portfolio, divided by shares outstanding.

NAV is always calculated as of the day’s closing prices. An ETF or closed-end fund, in comparison, changes in value throughout the trading day just like shares of stock that are publicly listed. This is most commonly used to track mutual fund performance. As NAV rises, it indicates positive results. And as it falls, it means a negative outcome.

However, NAV is not necessarily the best method for judging a fund’s performance. Because a fund pays all of its capital gains, dividends, and interest to shareholders, different levels of current income will not be reflected in the reported NAV price. A more accurate measure is the fund’s annual total return.

Key Point

NAV does not give you the best picture of relative value, because all current earnings are distributed in cash or reinvested to buy new shares; total annual return is a more reliable comparative measurement of fund performance.

Performance is going to depend on the type of fund and how that classification performs in today’s market. Of course, the performance also varies based on management’s selection of a portfolio and timing for its entry and exit decisions. There are nine major categories. These are:

  1. Equity funds are the best-known ones. These invest in stocks. Because mutual funds are considered ‘institutional’ investors, they trade in large blocks of stock compared to the relatively few shares traded by individuals, or retail investors.
  2. Fixed-income funds (or ‘income funds’) specialize in either bonds generating interest income, or stocks with exceptionally high dividends. These are both forms of income. Capital gains are also earned in these funds from selling stock above purchase price, or from redeeming bonds at face value when they were purchased at a discount.
  3. Balanced funds combine potential growth from equity investments with potential income from dividends and interest.
  4. Specialty funds are designed to pursue companies with specific features, in addition to defining themselves as equity, fixed-income, or balanced funds. An example is the ‘green fund’ which includes only green technology companies in their portfolio. A global fund is another specialty fund that seeks positions in companies operating or based outside of the United States.
  5. Money market funds invest only in instruments in the money market, which are interest-yielding and will not offer growth potential. These include certificates of deposit, U.S. Treasury bills, bankers’ acceptances, and commercial paper.
  6. Hedge funds are not set up or regulated like any others in the fund universe. They are usually private partnerships that accept a limited number of investors and require a large deposit to participate. They use leverage through derivatives and other advanced techniques to create high returns (or high losses).
  7. Capitalization-based funds specialize in companies of a specific market capsize. So there are large-cap, mid-cap, and small-cap funds suited for investors who believe the best returns will be found in one of those categories.
  8. Index funds do not buy stocks specifically but invest in the broader market by tracking performance in an index like the S&P 500, the Dow Jones Industrial Average (DJIA), or other indexes that define and track market performance.
  9. Tax-free bond funds are similar to fixed-income funds in the sense that they take positions in bonds. However, this group buys only those bonds that are exempt from income tax. To determine whether such a fund is appropriate, investors should compare the after-tax return from the fixed-income fund to the tax-free return in this type of fund.

Other Conduit Investments

In addition to mutual funds, there are many other ways to pool investments with others and within an organized structure, A mortgage pool is a mutual fund-like company that specializes in taking shares of a collection of mortgages. These mortgage-backed securities are offered by lending institutions sponsored or guaranteed by the U.S. government.

Key Point

The widespread failure of mortgage-pool-based investments in 2007 – 2009 proves that excessive risk invariably causes a strategy to fail.

These organizations include the Government National Mortgage Association (GNMA), also known as Ginnie Mae; the Federal National Mortgage Association (FNMA), or Fannie Mae, which also sells REMICs; and the Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac. All of these market a mortgage-pool product called the Real Estate Mortgage Investment Conduit (REMIC). These mortgage pools have become controversial in recent years, due to excessive marketing and lax credit standards among participating lenders. Collectively, these organizations created a secondary market for real estate lending. Local institutions underwrote loans and then sold those loans to one of the big national groups, which then placed the mortgage into a pool with thousands of other loans and sold shares to investors. At least to some extent, excessive secondary market activity is what led to the housing bubble and crash of 2007â “2009.

Valuable Resource

To learn more about the secondary market for real estate and mortgage pools, check the websites for each of the three major organizations:

  • Ginnie Mae, www.ginniemae.gov
  • Fannie Mae, www.fanniemae.com
  • Freddie Mac, www.freddie.mac.com

Another way to own real estate but have it act like a stock is through the Real Estate Investment Trust (REIT). This is a pooled investment that combines the money of thousands of investors to buy, construct, or develop real estate properties. REIT shares trade on public exchanges just like stocks, making them very liquid. There are many types of conduits that specialize in all markets: stocks (equity), debt, and real estate. The right one depends on your own risk tolerance and personal investment goals.

Key Point

The REIT is a good way to invest in real estate but maintain liquidity and diversification.

Variable Annuities

A final type of pooled investment is the variable annuity. This is similar in many ways to mutual funds, but with some equally important differences as well.

Variable annuities include either a lump-sum investment or periodic investments. An annuity, or series of payments, is guaranteed years later, but the amount varies based not only on how much is deposited but also on how the portfolio performs.

Key Point

Variable annuities are similar to mutual funds in many ways, but they are insurance products and involve many costs and fees.

Because this is an insurance product and not like other investments when you buy into a variable annuity, you are not an investor, but an annuitant. The future date when payments will begin is established in advance and is usually a specific age or retirement date. Within the variable annuity, you are given a range of choices about where your money will be placed. These include a range of mutual funds, including splitting your money within one mutual fund company, but among a family of funds, it offers.

Advantages that variable annuities offer over mutual funds include tax-deferred growth, a death benefit that goes to your beneficiaries and is equal to account value or a guaranteed minimum, and options for how you receive payments later (including a stream of payments for a guaranteed number of years, or guaranteed lifetime income, for example).

Disadvantages include a surrender fee if you withdraw funds early; expense fees that may be greater than comparable fees in mutual funds; and the overall complexity of the variable annuity contract when compared to buying shares in a mutual fund. Because most fees are not charged upfront, variable annuities look like no-load funds. But fees are charged during the ownership period in the form of back-end penalties for withdrawal.

Key Point

The best way to select any pooled investment is by ensuring that it matches your investment objectives and that you completely understand what fees, risks, and requirements are involved.

Pooled investments — whether organized personally through an investment club, or more formally through a mutual fund, real estate pool, or variable annuity — are popular because they solve a familiar problem for a vast portion of the investing public. They automatically diversify investments, make reinvestment of income easy and automatic, and rely on professional management to make tough portfolio decisions.

There is an alternative to investing, through various trading techniques. The distinction is made on three levels:

  1. Holding period: Investment usually means a buy-and-hold strategy over many months or years; trading means moving in and out of positions in very short time spans, days or even hours.
  2. Risk level: As a general rule, investors tend to be more conservative and traders more speculative in their market strategies.
  3. Source of information: Investors are more likely to use fundamental analysis and to rely on financial statements and trends. Traders are more inclined to use technical analysis, study price charts, and time entry and exit based on price trends.

The many strategies used by traders are explained in Day and Swing Trading, beginning with an analysis of Trading Risks.


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