Mutual funds offer liquidity, diversification over stocks

October 21, 2005

The business of cleaning up big business is still largely unfinished.

Sure, a few highly placed execs have been pushed out of their jobs and there have been some rule changes designed to clean up the investing marketplace, but many financial experts feel that all of this has provided us with only a peek at the tip of the iceberg.

There's bound to be more hanky-panky going on, they say. Unfortunately, they're probably right. The business of cleaning up big business is still largely unfinished.

So where does this leave a medical professional trying to build an investment portfolio that will put the kids through college or provide for a secure retirement? How can you as an investor protect yourself against another Enron or AIG fiasco?

If you're still investing in individual stocks, you'd best understand that you have a tough row to hoe. In order to make sensible choices, you have a lot of work to do. You must be prepared to scour news reports and analysts' opinions, study each company's annual reports and filings of 10-K reports (AIG's 10-K report for 2004 was nearly 400 pages), and spend lots of time on the Internet looking for clues about what's happening at the companies that interest you.

Then, you must take great care to diversify your investments among different industries, different companies within each industry, different-sized companies, and companies with different management philosophies.

To make matters worse, despite the wealth of material available to the determined researcher, it's still a crapshoot when it comes to picking individual stocks. Even ratings by Wall Street's high-profile analysts are proving to be undependable. Straight talk has never been the long suit of Wall Street's rating "experts."

What does it mean?

Does all of this mean that you shouldn't be investing in the stock market? Absolutely not.

When it comes to investing for the future, there simply is no getting away from the stock market. If there's one concept that financial experts agree on, it's that investing in stocks offers the best potential for long-term profits - and history clearly supports their position.

On average, the stock market has generated an annual return of about 12 percent over a period of many decades. No other form of passive investment comes close to that performance. That's why some portion of every investor's portfolio should be in the stock market.

Of course, the operative phrase here is "on average." Sure, the average return on stocks is great, but the ordinary investor, it turns out, has a tough time picking out stocks that will provide that average return or better.

Mutual funds

Further, primary research just isn't everyone's cup of tea, especially busy professionals in practice. Slogging through an endless stream of annual reports, prospectus, stock tables and other arcane statistics might drive some people to the edge of madness. If that kind of punishment is not for you, forget about investing in individual stocks. Instead, do what the smartest investors do: Buy only mutual funds. Let those experts who are paid to absorb all that punishment decide which stocks to buy.

Mutual funds are the small investor's research expert. They are companies set up to accept your money and make investments on your behalf. When you buy mutual fund shares, you are a shareholder, an owner of that mutual fund, with voting rights in proportion to your ownership of the fund.

Briefly, there are two main reasons why mutual funds are preferable to individual stocks: