Mutual funds may not look sexy, but for most people, they're the best way to achieve financial goals. That's because mutual funds are professionally managed and offer diversification, which you don't get when you buy individual stocks.
First, let's consider why professional management matters. When you buy a fund, the fund takes your money and pools it with others' money into one big pile. The fund manager's job is to decide which stocks to buy, sell, and hold—while you're busy at work and raising children. Each manager uses a methodology or discipline to select stocks or bonds. Every day, fund managers and their team of analysts examine the companies they own to see if they still fit their criteria for securities selection.
Fund managers spend a lot of time visiting the companies in which they invest. Sure, they can read a research report about a company. By meeting company executives face-to-face, fund managers can get a much better sense of how the company operates and what advantages it has over competitors. Fund managers also visit with a company's competitors. Plus, managers do what's known as "channel checks," which means they visit the company's stores or customers. For example, if a fund manager owns shares of Best Buy (BBY), he'll visit a store to see how many customers are there and what people are buying.
The other advantage of owning a mutual fund over an individual stock is diversification, which you don't get if you invest small amounts of money in a few securities. For example, if you have $10,000 to invest, you can buy maybe 100 shares of five stocks. When you buy a mutual fund, it might own 50 to 100 stocks, so if one stock blows up, the entire fund won't go down in flames. The manager makes sure that the fund is not too heavily exposed to any one stock or sector.
That means fund managers have to do their own housekeeping. They analyze the weightings of companies the fund owns and watch as the stocks become more or less valuable. They will sell some shares of one holding if something else looks more attractive.
Most individual investors don't have the skills and time to monitor and examine each holding the way a professional fund manager does every day. Fund managers are trained to stick to their discipline and be decisive, and are not emotionally attached to your money. Professionals, whether they're in sports or management or investing, usually know the ropes much better than amateurs.
There's another advantage of mutual funds: Investors tend not to trade funds as often as stocks, which helps their returns over time.
Certainly, mutual funds don't have the pizzazz of the hot stocks of the moment. If you're looking for entertainment, go gambling in Las Vegas. But if you want to accumulate real money for your retirement and other goals, mutual funds are the safer bet.
[For tips on how to find the best mutual funds, see 5 Ways to Find the Best Mutual Funds.]
Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast-to-coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April, 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC registered investment adviser which provides mutual fund and asset allocation recommendations and research to stores in The Mutual Fund Store system.