You've Got a Gain. Now What?

One of the most glorious sensations an investor can feel is when a stock rises substantially from the price at which it was purchased. It is an energetic, empowering boost to the ego. It represents tangible confirmation that said investor is competent at the game of equities and more than justified in taking on the Wise of Wall Street.

Capital gains: a beautiful thing
An even better feeling comes after profits are locked in. Sure, a nasty case of seller's remorse might shake your psyche (I recently experienced a tough bout of this odious malady after departing from ownership of a particularly resilient real estate investment trust exchange-traded fund), but a profit is a profit. It's why we invest, after all.

But here's the million-dollar question: Once you take a gain, what should you do with it?

Capital gains: the intellectual conundrum
Reinvesting a winning bet in the stock market is a significant challenge, and it's not to be taken lightly. That's particularly true if you sit back and watch that winning bet issue a press release that catalyzes further capital appreciation. It may, after all, become clear that you could've just stayed in the stock. But nobody should regret taking a profit too early -- let's face it, no one is capable of telling the future or getting every trade correct.

Nevertheless, investors must reinvest their profits. That's why we're investors. We've made a choice to take some financial holdings and buy solid companies with great future prospects. Problem is, though, sometimes a gain is decimated by a bad reinvestment decision. (In case you're wondering: Yep, I've been there and done that.)

So, what should you do? Say you've been riding Google (NASDAQ:GOOG) for a long time now and you're getting nervous. Your initial monetary outlay has quadrupled in value. You're shaky. You take your profits (nothing wrong with that). But you don't want to park it in money markets or certificates of deposit, especially if the Fed is closer to the end of its tightening cycle. You want to be in equities, but you're unsure of where to find the next Google. (Or, to be more realistic -- you quadrupled your money, after all -- you're unsure of where to find the next market-beating opportunity.)

I have a suggestion.

The big idea
I offer you ... mutual funds. That's right: mutual funds.

Mutual funds can easily serve as a repository for your hard-earned market gains. These investment vehicles offer so much value in terms of proper profit management. What you're essentially doing is handing your money over to another group of individuals and paraphrasing a famous Clint Eastwood line: "Go ahead ... make me money." (Or something like that.) You're taking the power of decision and transferring it to a team of people who have (hopefully) a fiduciary sense of responsibility.

Does that sound like giving up? It shouldn't. Recall one of the cardinal rules of successful investing: diversity. That means you should hold positions in several sectors and asset classes -- so you might hold a media company like Viacom, a financial concern like Citigroup (NYSE:C), and a technology giant like Microsoft in addition to a few bonds and some cash for the long term. In my view, it means that you must diversify strategies as well. Buying a stock is a strategy. Letting someone else buy the stock for you is, obviously, a different strategy. Just as a smart investor would want exposure to international stocks and perhaps valuable commodities, so too would a smart investor want exposure to other kinds of market mechanisms, such as options and short selling, to name two examples.

In my mind, exposure to the ideas of a money manager is just another sensible bit of diversification. But a lot of you are probably in my same boat. You most likely (1) own a passive fund or ETF such as Vanguard 500 Index or SPDRs (AMEX:SPY) or (2) are so addicted to buying shares of individual stocks that you don't have a lot of extra investment dollars lying around to buy into a quality open-ended financial instrument.

This is the beauty of my proposal. If you've done your homework and have devoured everything you can, you probably don't need to inject any more capital into your account to take advantage of the mutual fund marketplace -- you've already got the extra liquidity lying around from some profitable sales. You're all set to use some of the house's money to pick up some quality mutual funds.

But while you may be one heck of a stock jock, you're probably not a fund geek. Not to worry; we have one for you -- not to mention a service that cherry-picks the cream of the fund industry's crop every month. So far, the recommendations that have appeared in the Motley Fool Champion Funds newsletter -- a group that ranges from growth-oriented funds that invest in Yahoo! (NASDAQ:YHOO) and eBay (NASDAQ:EBAY) to picks that favor more buttoned-down fare such as PepsiCo (NYSE:PEP) and Pfizer (NYSE:PFE) -- have beaten the market handily. If you'd like to peek at the entire lineup of funds, take a free trial and check out the scorecard for yourself.

But wait. I can hear the naysayers ...

In part 2, Fool contributor Steven Mallas continues his discussion of mutual funds and how to select the right ones to use as reinvestment vehicles. Steven owns shares of the Vanguard 500 Index fund. Pfizer and Microsoft are Motley Fool Inside Value recommendations. eBay is a Motley Fool Stock Advisor recommendation. The Fool has adisclosure policy.