When one is just learning to invest, he usually starts off with savings accounts and bonds to earn interest. As his knowledge increases, he might then venture out into mutual funds. And as his knowledge grows further, his portfolio might then increase to include index funds and stocks. One might ask which type of investment vehicle is better. Hopefully in this article, it will answer the questions a new investor might have.
Mutual funds are a basket of stocks picked by a fund manager. You pick the mutual fund according to your investment style and tolerance level. Since someone is doing the work for you in picking the stocks, there’s a management fee associated with it.
Something like a mutual fund are index funds. Index funds are also a basic of stocks but these baskets track a indices like the Dow Jones, S&P 500, NASDAQ, etc. Since all one has to do is buy whatever stocks make up the index, the management fee is quite a bit lower than those funds which are actively managed like the traditional mutual funds.
Finally, if you feel like you have done your homework in researching stocks, you can create your own stock portfolio with stocks of your own choice.
So out of these three options, which is best? Frankly, mutual funds were a good choice when they first began. Their purpose was to alleviate the decision making process from the investor. However, due to the plethora of mutual funds themselves, it has become as much guess work as investing in stocks alone. Plus, their management fees make them expensive to own. They usually run around a 2-3% management fee compared to the 0.25% management fee of index funds which most mutual funds copy buying stocks of major indices anyways so why pay the extra fees?
In fact, buying index funds was the advice of famed billionaire Warren Buffett for those who don’t have the time to truly devote to investing for themselves. However, if you are keen to invest for yourself and can take a long term approach to investing, then you might actually follow Buffetts stock picks and pay attention to what he’s buying. Studies show that even if you don’t own Buffett’s company Berkshire Hathaway stocks, you can still buy individual stocks in his portfolio to make a profit. His long term stocks are usually right on the money if you have a long term investment horizon.
If you are learning about investing, go with index funds first to get your feet wet and when you’re ready to get serious, take a gander at what Buffett is buying. After all, it literally pays to learn from the best.