Should we invest in stocks or in mutual funds?

One of the strategies we follow in our financial planning is safe investments. However, investment is never safe. The question is how much risk we should take. Investment is not our main stream of income. We use it as a mean of savings. This is one of the reasons we take low risks in the area of investment. Another reason is, we are not experts; we are learning as we go.

One feature that caught our attention while we were doing some extensive research on strategies for saving is the diversity in an investment portfolio. The dilemma of which stock to own is somewhat addressed by diversification of a portfolio. The term diversification is widely used by financial advisors. We did not have much idea about investment and diversification until a few years back when we started to think about long term financial planning. As the term diversity figuratively suggests, a portfolio should have divergence from different angles. We will explain the details soon in this article.

What are Stocks and Mutual funds
Stock: A stock is a unit of ownership of a company. Another alternative term is share. Stocks do not have annual fees but they have transaction fees. That is, an investor generally has to pay a fee of $5 to $10 to buy or sell stocks. The fee applies to each transaction.
Mutual Fund: A mutual fund is generally composed of stocks of multiple companies. Every mutual fund has a fund manager (to the best of my knowledge). The fund manager makes sure the objective and goals of the mutual fund is maintained. Since there is a fund manager, there is an annual fee. Some mutual funds have minimum investment limits. For example, consider that a fund manager maintains a mutual fund called, BIOE, composed of stocks of biomedical engineering companies. BIOE may have a restriction that the minimum investment on BIOE can be $3000. Other possible restrictions I remember are, time and balance restrictions. Time restriction is something like this: there will be a penalty of 1% if the investor pulls out any part of the investment before completion of three months. Balance restriction is something like, the balance cannot be any lower than $1500, or so. If it comes below $1500, the annual fee will increase by 0.5%. Please make sure to study the prospectus of every mutual find you invest to. Based on our research, mutual funds offer a good tool for long-term investment.
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Diversification may come from different directions in a portfolio. When I say portfolio, I mean a mix of funds. Diversification is necessary because we really do not know which company will perform well and which company will not do so well. Of course, market analysis and keeping an eye on the news help but the stock market is so unpredictable time-to-time that people doing a full-time job might not have enough time to check the funds and do a market research everyday. People may be able to check the funds every month or sometimes every few months. We prefer a mix of companies or funds that are historically strong and steady. Investing most of the money in one company, even if the company has a great history, is not a good idea because the fate of a company may depend on many uncertain factors. It is difficult to evaluate the factors for ordinary investors like us. We try to maintain the following diversity features to be in the safe side of the equation.

Keep hitting the NEXT button and you will get more of the diversity aspects I am talking about.

Stock diversity

The companies you choose must have some diversified area. For example, you can choose areas like entertainment, consumer products, service, technology, energy sector, etc. From each area, you can choose stocks of one or two companies. Some example stocks in the entertainment sector are Netflix (NFLX), Disney (DIS), and Lions Gate Entertainment Corp (LGF). Some consumer product stocks are Procter and Gamble Co (PG), CVS Health Corp (CVS), Coca Cola Co (KO), etc. Service stocks may have many categories like education and training services, consumer services, shipping services, advertising, publishing, broadcasting and many other service providing companies. There can be hundreds of companies under these areas. One may choose a few based on past histories of the companies.

One can easily find a few technology companies based on internet research. Some examples are Apple Inc (AAPL), Microsoft Corporation (MSFT), Google known as Alphabet Inc (GOOGL), and many other stocks. I do not know what category Amazon.com, Inc. falls into. It can be a consumer product company or it can be a service provider. It does not really matter. Amazon has shown steady growth over the past few years. I am providing some examples NOT because they are good stocks but only as a reference to explain the categories. In practice, one needs to find out which companies she/he should invest in after doing a market research. Along with the growth history, profit is a parameter that one needs to analyze for diversification. I will talk more on this in a few minutes.

We are currently comfortable with analyzing company stocks and mutual funds. As stated in our previous article regarding investment, we prefer to use transaction fee-less financial institutions for company stock investments. The reason is, fees are sometimes too large for small amount of frequent transactions. Transaction fee-less institutions like Robinhood generally do not have mutual funds because of their slim profit margin. Mutual funds are managed by an expert appointed by a financial institution. Example of financial institutions that have mutual funds are: Fidelity Investments, Voya Financial, Lincoln Financial Group, Vanguard Group, Prudential, and many other companies. Investors generally do not pay transaction fees for mutual funds but there is an annual fee which may be as high as 1%, or such. We must check if historic data suggests that the annual growth of the fund is higher than the annual fee.

Some mutual funds may have transaction fees but most financial institutions have ample mutual funds that do not require any fees for transactions. Some mutual funds may have short-term redemption fee. A short-term redemption fee is something like the following: there will be a redemption fee of 1% if the investor withdraws the money within three months after the investment. 

We should read terms and conditions carefully before purchasing mutual funds (as well as stocks).

Concluding remarks: Financial planning of a family is a continuous process, not just an activity. The goals and objectives change over time. Example of different goals are: save for an emergency fund, save for down payment to purchase a house, save for college fund, send kids to college, plan for retirement, move investment portfolio to lower risk category as retirement nears, etc. Therefore all family leaders (dear wife and dear husband) need to stay on top of the analysis and planning.

Please let us know if you have any question or comments.

Settle in El Paso team

Note: We first published this post on August 9, 2016. We have reported this after some updates.



Comments

6 thoughts on “Should we invest in stocks or in mutual funds?

  1. You recently said you liked my post on https://elspethc.wordpress.com/2016/10/06/realize-get-out-of-the-box/
    Did you like it? Really? Or just think it was about finance and make a quick click?
    I see a lot of good things on your other posts, childbirth, post-partum depression etc. So I want to ask you to tell me what you really think about our current monetary system, and whether you will be acting to push – somehow – for reform. I do know that in the meantime we are all in “the system” within which you are suggesting a variety of choices.
    Out of the Box – let me know what you really think about monetary reform. You can write effectively, it would be good to have you campaigning.
    1. Dear Elspeth,
      Thank you very much for your comment. We have left a comment in your post a few minutes ago. We did read your post. It is excellent and fosters thoughts about monetary systems. The fact is that we do not have much knowledge on the topic. Thank you very much for your thoughtful post and your invitation to participate in your campaign. While we loved your appreciation regarding our writing, we are not worthy of participating in your campaign because of our lack of knowledge regarding monetary systems, macroeconomics, or even finance. We have been writing based on our experience. Both of us (dear wife and dear husband) have different professional background than what have written so far in our blog.

      Have a wonderful evening.

      Settlers, Settle in El Paso

    1. Your blog if full of life. A must follow as well. We are happy to know that you liked the post. Thank you for visiting, following, and commenting.
  2. Lots of information here! Thanks for sharing. Investing is tough, but it can be beneficial. You have to do your homework and it looks like you did! Have a wonderful weekend!
    1. I am with you; investment is tough but can be beneficial in the long run. At first we were enthusiastic but given that it requires constant monitoring, we had to set monthly automatic transfers to a number of stable mutual funds. We check the status every few months now. You too have a wonderful weekend!

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