One of the most important and difficult choices you will face as a new investor is whether you should invest in equity funds or individual stocks.
Investing in an equity fund means buying shares of a portfolio overseen by a professional portfolio manager, who is responsible for picking the stocks in the portfolio as well as the buy, sell, and hold decisions.
- Equity funds are a good option if you like to watch an investment's performance but would rather defer to the professionals for research and analysis.
- If you are investment savvy or prefer to build your own portfolio, you can retain more control over investing decisions by selecting individual stocks.
- Learning about a company and reading its financial statements are two good ways to evaluate a company's stock.
- A diversified portfolio can consist of a handful or hundreds of securities, so be sure to consider this factor when choosing to manage your own.
Equity Funds vs. Individual Stocks
Once you've chosen a good equity fund, your responsibility is to continue buying shares, reinvesting your dividends and capital gains, and checking the mutual fund's annual report each year. Your goal is to ensure that the management company is sticking to the financial philosophy in which you believe and that you remain comfortable with the holdings. In a lot of ways, it is like checking the performance of a building manager you hire to oversee your rental properties.
On the other hand, picking individual stocks means that it is your responsibility to build a portfolio, pour over annual reports and 10k filings, make buying and selling decisions, and keep up to date with what is happening at each of the companies in which you maintain an investment. It is, after all, your hard-earned money. For a lot of people, that sounds like intellectual torture.
When building your own portfolio, you should also have a good idea of your personal risk tolerance, your current budget, and your long-term and short-term investing goals.
Here are a few ways to tell whether you should invest in equity funds or pick your own individual common stocks instead.
Reading Financial Statements
Can you read GAAP financial statements, including income statement and balance sheets? If you have that skill, then selecting your own individual stocks shouldn't be any more difficult than analyzing a private business opportunity such as investing in a limited liability company (LLC).
In such a situation, it seems a little silly to hire a professional money manager to sit around and research businesses for you all day, unless you would rather focus on your primary occupation.
For some people, there are very few things more enjoyable than finding a great company and learning about its business, industry, products, cost inputs, and strategy, and how it fits into the world.
Do you love being able to walk into a liquor store and know the gross profit margins for the company that distills a certain brand of whiskey? Do you enjoy being able to pass a hotel and know the average cost per room to construct it? What about discussing the total pre-tax profit it should be generating if it is well run and moderately successful? Studying businesses (and individual stocks, by extension) is a way to understand the world and what people truly value.
If you don't care about those things, it doesn't make a lot of sense to waste your time trying to find individual companies in which you can become a partial owner. Pay a professional their management fee, and acquire good, well-diversified equity funds instead.
Equity funds can be actively managed, meaning that the portfolio manager uses their own discretion, or passively managed, meaning that the fund follows a market index. Passively managed funds typically have lower fees than actively managed ones.
Multiple Positions vs. a Handful of Funds
Even a focused investment portfolio will likely include 10 to 20 stocks; a widely diversified portfolio could contain 30 to 100 stocks. Do you want to have to keep track of all those securities? The dividend dates and income? The cost basis for each position?
If you don't mind and have a large enough portfolio to justify it, individual stocks might be for you. If you want to be able to build your entire investment portfolio history on a single, short spreadsheet, equity funds are probably the better selection.
Which Should I Choose: Equity Funds or Stocks?
If you aren't able to think like a long-term investor, you might want to build in a layer of protection and choose equity funds over individual stocks. Unless you go the ETF (exchange-traded fund) route, mutual funds only adjust their stock prices, or net asset values, once per day. That frees you from the need to be glued to a screen or panicking over a fifty-cent move in a blue-chip stock that shouldn't cause you any consternation.