The Smart Move for Skittish Investors

Investing in individual stocks gives you the potential for amazing rewards. But if the volatility keeps you awake late at night, there's no shame in retreating to the smoother ride you can get from other types of investments.

Every day, the bear market's roar sends several stocks down by double-digit percentages. Look at a few losers from last week:

Stock

Day

Drop

Harman (NYSE: HAR  )

Aug. 15

(14%)

Flowers Foods (NYSE: FLO  )

Aug. 14

(12.5%)

AMR (NYSE: AMR  )

Aug. 13

(10.9%)

McDermott (NYSE: MDR  )

Aug. 12

(13.5%)

Coeur d'Alene Mines (NYSE: CDE  )

Aug. 11

(16.8%)

Source: WSJ.

To put those figures in perspective, the S&P 500 has lost a bit over 10% for the entire year. And you know well what impact that drop has had: fear and anxiety about a possible recession run rampant, and some have even started to talk about a repeat of the Great Depression of the 1930s. So to suffer that kind of loss in a single day -- believe me, if that doesn't put you into a panic, you've got nerves of steel.

Understanding risk tolerance
When it comes to investing, everyone's different. Some people are able to take sharp declines in particular stock holdings in stride -- as long as their overall portfolio value drops more modestly, they can handle a bad day from one or two of their individual stocks. A well-structured diversified stock portfolio actually embraces this kind of price behavior, realizing that if a certain stock plummets, other holdings will cushion the blow to your total net worth.

On the other hand, some investors simply can't see their stock portfolios as one cohesive unit. Instead, they want each of their holdings to do well -- and when they don't, it represents a failure in judgment and brings about the pain that losses inflict on our emotions. Left unchecked, these emotions can lead you to make even bigger mistakes than the one that got you to buy the losing stock in the first place.

The solution for skittish investors
As much as your rattled nerves may want to take a break from turbulent markets, you don't have to give up on stocks entirely to get some relief. If the last year or so has shown you that investing in individual companies isn't your cup of tea, you have a perfectly good alternative that will still give you the stock exposure you need for long-term portfolio growth: mutual funds.

Most mutual funds hold dozens of stocks. As a result, when one or two take a big hit, the mutual fund will drop, but not nearly as severely as those individual stocks. For instance, on July 15, Freddie Mac (NYSE: FRE  ) fell over 25% on fears that the mortgage lending giant was insolvent. Yet a top institutional holder of Freddie Mac stock, the Legg Mason Value Trust (LMNVX), only lost about 2% of its value that day.

The price you pay
Now it's true that nothing comes without cost, and funds are no exception. You may not bear the full brunt of a Bear Stearns-style implosion, but you also won't get the full benefit of a multibagger stock. American Funds Growth Fund of America (AGTHX), for example, holds a 3.9% stake in Intuitive Surgical (Nasdaq: ISRG  ) . The fund is up over 10% per year since 2003, but that pales in comparison to the 82% annual return for Intuitive Surgical -- nearly a 20-bagger in those five years.

But being comfortable with your investments is important. Investing in stock funds can keep you on the path toward your financial goals, letting you keep broad exposure to the stock market while also helping you avoid the mistakes individual-stock investors make. If funds make you feel more comfortable during tough markets than individual stocks do, don't hesitate -- make the leap today. Giving up some upside potential on your investments is worth it -- especially if it makes bear markets easier to put up with.

For more on funds, read about:

How can you find the right fund to replace a portfolio of individual stocks? Our mutual fund newsletter, Champion Funds, can give you the guidance you need. Find out how with a free 30-day trial.

Fool contributor Dan Caplinger hasn't given up on individual stocks, but he has plenty of his money in mutual funds. He doesn't own shares of the companies mentioned in this article. Intuitive Surgical is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy involves no risk at all.


Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

DocumentId: 709116, ~/Articles/ArticleHandler.aspx, 4/17/2014 5:31:26 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement