An investor came to us asking about the old advice of investing in mutual funds first, then, once you reach a certain asset amount, broadening your investments with individual stocks. Does that still hold up in today’s market? It depends on how much involvement you want to have.
When you start investing, diversification is the main issue. You want to diversify across the 11 stock market sectors and may even want to diversify among market capitalization or asset classes.
It used to be that you had to call a stockbroker to buy a whole share—let’s say $480 for one share of NVIDIA—plus a $20 trade commission fee to have someone place the trade for you. With today’s technology, you can buy fractional shares of stocks at no commission, so the hurdle is much lower when buying stocks than in the past. You can even buy and sell stocks through an app on your phone, thus eliminating the middleman.
While the purchase process is easier, someone must still do due diligence, researching each of the stocks you want to own. It comes down to this: with individual stocks, you’re going to need at least 20 to 25 individual stocks to be aptly diversified—that means researching 20 to 25 companies—more if you want more than just 20 to 25. You also need to ensure you’re appropriately allocated so you’re not 90% in technology—easy to do if you just picked the largest, most popular stocks these days. This process is considered actively managing your portfolio. Stock investing is a very time-consuming hobby.
The easier way to invest is to buy shares of a mutual fund. Mutual funds are a basket of stocks sold as a unit. Actively managed funds are overseen by an investment adviser or brokerage house; however, with that management comes expense ratios—they subtract the cost of the management services from your total. While expenses may only be 0.50% , they still add up over time. For every $1,000 you own, you’re paying $5 in expenses annually; therefore, your fees can significantly grow over 20 years of buying more shares, plus market growth. The advantage is that with an active manager, there is a chance you could outperform the market, but there is also a chance you’d underperform.
Exchange-traded funds (ETFs) are a similar basket of stocks, but they are passively managed in that they mirror an index or sector. Their expenses are often less than most mutual funds, often under 0.20%. With a passively managed ETF, your performance will be close to what the index shows. ETFs aren’t a perfect solution because you may not always want to follow an index. With macroeconomics, sometimes you may want to protect your assets from market volatility but remain invested.
The other difference between mutual funds and ETFs is that mutual funds are traded once daily based on the net asset value of the underlying stocks. When you sell, you sell shares back to the mutual fund company. ETFs trade throughout the day like stocks. When you sell shares, you’re selling to another third party through an exchange.
Mutual funds and ETFs provide an easy way to diversify among sectors, company size, and even asset classes. You just need to be aware of the associated costs. Investing on your own is much different than hiring an adviser to manage your portfolio for you.
If you have questions, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166