My colleague Selena Maranjian hit the nail on the head with her mutual fund Valentine last year, and I'm in 100% agreement: I love 'em, too. I own a handful of individual stocks, but the bulk of my nest egg is invested in top-notch mutual funds for good reasons. Here are three of those reasons.
1. I hate losing money.
Investing luminary Warren Buffett's two rules are as follows: (1) Don't lose money, and (2) don't forget rule No. 1. Not coincidentally, with its stock portfolio and collection of subsidiaries, Buffett's Berkshire Hathaway (NYSE: BRK-B ) holding company is essentially a mutual fund in stock clothing.
Given that Buffett hates losing money, too, that makes complete sense to me. Because of their built-in diversification, funds are far less risky than individual stocks: With funds, your fortune isn't tied to the fate of just a handful of companies.
Instead, you can build a portfolio the intelligent way -- by, say, investing in an "anchor" fund that targets large-cap market-beaters such as Rio Tinto (NYSE: RTP ) , Freeport-McMoRan Copper & Gold (NYSE: FCX ) , and Qualcomm (Nasdaq: QCOM ) , each of which delivered annualized gains in excess of 20% for the 10 years that ended in May. Then, once that foundation is in place, you can plunk down smaller amounts on funds that favor speedier demons such as MercadoLibre (Nasdaq: MELI ) , Suntech Power (NYSE: STP ) , and Baidu.com (Nasdaq: BIDU ) , a trio that sports five-year earnings-growth estimates in excess of 25%.
Make no mistake, though: Funds aren't free of volatility. But if you're into what the pros like to call "principal preservation" -- and aren't we all? -- you'll be well served by world-class funds run by managers whose track records prove they can make the most of any market environment. That's a key criterion that I'm using to start up the Ready-Made Millionaire real-money investment service, where I've created a portfolio that stands to beat the market over the next five years and beyond.
2. I want to invest outside my core area of expertise.
I like to think I know a fair amount about both mutual funds and the domestic stock market. I'm less of an expert, though, when it comes to more esoteric asset classes such as, for instance, emerging markets and high-yield bonds. Based on my timeline and risk tolerance, though, I want exposure to both of those groups in my portfolio.
Enter mutual funds, which provide a no-muss, no-fuss way for investors to put money to work in important areas they might otherwise avoid. After all, the criteria for choosing a high-quality fund are the same regardless of what area of the market it targets. Among other things, savvy types will want to focus on fees, managerial tenure, and past performance on the current manager's watch. Drilling down from there, you'll also want to gauge the fund's strategy and tax efficiency, and you'll want to determine whether the manager invests his or her own money alongside yours. As I've pointed out before, few mutual fund data points will ever tell you more than that one.
3. I want to beat the market but sleep peacefully at night.
Last but not least, I love funds because they provide a great way to grow and protect your nest egg while you beat the market. Index funds such as Vanguard's dirt-cheap 500 Index (VFINX) can play a role in a smartly designed portfolio -- they offer strategic diversification -- but I favor actively managed picks because I want to surpass the market's average. The most you can realistically expect with passively managed funds is to lag the benchmarks they track by about the amount of your annual expenses.
Not so with active funds, which is why they are the primary object of my affection.
If you'd like more information about the Ready-Made Millionaire portfolio, which I'm engineering as we speak and will consist primarily of funds with a smattering of stocks and ETFs, simply enter your email address in the box below.