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Why would a Person Choose a Mutual Fund over an individual Stock

    IndianMoney.com Research Team | Wednesday, April 08,2009, 12:52 PM
 

There are several reasons why an individual may choose to buy mutual funds instead of individual stocks. The most common are that mutual funds offer diversification, convenience and lower costs.

Many experts agree that almost all of the benefits of stock portfolio diversification (the benefits derived from buying a number of different stocks of companies operating in dissimilar sectors) are fully realized when a portfolio holds around 20 stocks. At the point that a portfolio holds 20 stocks from 20 companies operating in different industries, almost all of the diversifiable risk associated with investing has been diversified away. The remaining risk is deemed to be systematic risk, or market-wide risk, which cannot be diversified away. Since most brokerage firms having a minimum share purchase requirement, it's hard for many investors to afford 20 different stocks.

The convenience of mutual funds is undeniable and is surely one of the main reasons investors choose them to provide the equity portion of their portfolio, rather than buying individual shares themselves. Determining a portfolio's asset allocation, researching individual stocks to find companies well positioned for growth as well as keeping an eye on the markets is all very time consuming. People devote entire careers to the stock market, and many still end up losing on their investments. Though investing in a mutual fund is certainly no guarantee that your investments will increase in value over time, it's a way to avoid some of the complicated decision-making involved in investing in stocks.

Many mutual funds like a sector fund offer investors the chance to buy into a specific industry, or buy stocks with a specific growth strategy such as aggressive growth fund, or value investing in a value fund. People find that buying a few shares of a mutual fund that meets their basic investment criteria easier than finding out what the companies the fund invests in actually do, and if they are good quality investments. They'd prefer to leave the research and decision-making up to someone else.

Finally, the trading costs of buying and selling stocks are often prohibitively high for individual investors. So high-priced in fact, that gains made from the stock's price appreciation can easily be canceled out by the costs of completing a single sale of an investor's shares of a given company. With a mutual fund, the cost of trades is spread over all investors in the fund, thereby lowering the cost per individual. Many brokerage firms make their money off of these trading costs, and the brokers working for them are encouraged to trade their clients' shares on a regular basis. Though the advice given by a broker may help clients make wise investment decisions, many investors find that the financial benefit of having a broker just doesn't justify the costs.

It's significant to remember there are disadvantages of mutual fund investment as well, so as with any decision, educating yourself and learning about the bulk of available options is the best way to proceed.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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