Stocks and Mutual Funds
It is very hard for a simple stock investor to be able to pick the best performing stocks at any particular time. You can imagine going through the hundreds of stocks in the London Stock Exchange trying to decipher the best stocks from the poor performing ones. It could take years before one became good at it.
Enter the mutual fund, which is simply a fund where investors put their funds in one account and hire a manager to make the stock picking decisions for them. Mutual funds have now become the vehicle in which small investors are able to invest in stocks that were previously out of reach. They also help the investor reduce the risk inherent in stock trading. Some of the advantages of owning mutual funds instead of stocks include:
1. Diversification
Stock trading is risky. If you had a few hundred pounds and placed them in one or two stocks that go bust, you risk losing your whole investment. Mutual funds on the other hand invest in hundreds of different stocks. If a mutual fund has 1000 members who invest 100 pounds each, it will have more funds than the individual to buy different types of stocks.
This in turn reduces the risk for each investor since he only owns a very small percentage of a share that is falling.
The other side of diversification is that if you owned one stock and it doubled, you would get 100% in profits. If the mutual fund owned 50 shares and the stock doubled, you would only be up 2%.
2. Lower Costs
Most mutual funds charge you no fee or a very tiny fee to invest a small amount. The amount may be monthly. On the other hand, when you buy stocks with small amounts, your commission fees are very high. You are able to invest more of your small amounts in mutual funds than in buying stocks on your own.
When you buy and sell stock, you also have to consider the bid and ask spreads over and above the commissions. With mutual funds, this is not a concern, as you do not buy the stocks directly. Over time, these adds up to huge figures and thus more profits for you the investor.
3. Professional Investors
For the stock trader who has no idea about the stock market, mutual funds are a great way to hire experienced investors without paying too much. Since mutual funds are a very tiny percentage of the profits, the shareholder can take advantage of professional advice without the need to go to a full service broker who would charge more for the same advice.
The only thing the investor needs to ensure is that the mutual fund has good and ethical investment professionals to avoid loses due to mismanagement.
All in all mutual funds are a great option for those not conversant with the stock market and willing to spread their risk with other investors.
