A Stock Junkie in Fund Land

I'll admit it ... I'm a stock junkie.

Looking at a spreadsheet of my lifetime stock transactions, I've owned more than 100 stocks so far. Adding together the stocks that I track for my personal investing interest, the ones I follow in my work at The Motley Fool, and those that I have researched or followed during my career on Wall Street, I'd estimate that I've at least taken a peek at more than 4,000 stocks.

So any way you slice it, I'm a "stock guy." Yet I like and own mutual funds.

Mutual funds are not a large component of my portfolio, and I don't spend the majority of my time researching them. But they do have a definite role in my investment philosophy, and I believe they should have a place in most investors' portfolios. Because I don't spend a lot of time looking at mutual funds, I've really come to value our Motley Fool Champion Funds newsletter.

Diversification -- how they do the voodoo they do
First, let me say that I do not speak here of diversification as most people typically define it. It's old hat to say that mutual funds allow investors to diversify their investments, and, of course, that's true. Most mutual funds own 100 or more stocks, and that is certainly a more diversified portfolio than average investors could (or should) attempt on their own.

That's not to say that all of that diversification is necessarily a good thing. After all, once a portfolio reaches a certain size, the performance increasingly correlates with the overall market. Moreover, I often tend to agree with the more curmudgeonly investor types like Warren Buffett, who often believe there's only a limited number of stocks worth owning at any given time.

Instead, I speak of diversification of style. Every successful investor has his or her own unique approach -- whether it's a slight tweaking of someone else's method, a synthesis of two or more well-known philosophies, or something entirely new and unique. But not all styles work equally well at all times.

Say you're great at picking out the next great tech turnaround like JDSUniphase, but you're relatively clueless about value. Well, that's fine when the markets are bullish and risk-seeking, but your approach could take a painful bite out of your net worth if markets turn conservative and value seeking. In that case, a well-thought-out value mutual fund purchase could balance your holdings and end up boosting your performance a few percentage points.

And the reverse is also true. You might be a hard-core value hound and go to sleep with Berkshire Hathaway shares under your pillow but come up empty and befuddled when looking at the latest "new new thing." So why not tag along with a mutual fund that has a proven track record for riskier growth investing?

A mutual fund, then, can be an avenue toward embracing a successful approach without changing your own personal style. One of the surest ways to founder in investing is to try to be a jack-of-all-trades -- dabbling in growth today and going with value tomorrow. Buy a good mutual fund, though, and you can add a different approach to your portfolio without altering your own style -- a good idea even for successful individual investors.

Doing what you can't
Investing in quality mutual funds can also allow the individual investor to explore investment options that might otherwise be very difficult, risky, or outright impossible.

Take bond funds, for instance. Not many individual investors are going to have the financial resources to build a diverse portfolio of bonds on their own. But a relatively small amount of money invested into a bond fund like Dodge & Cox Income (DODIX) can provide good diversification and potentially some income as well.

That same rationale can be applied to many other sectors or asset classes, ranging from real estate to commodities. All of these asset classes have legitimate investment merits, but it can be difficult for the individual investor to participate safely. Owning a single real estate investment trust (REIT), for example, exposes you to a lot of company-specific risk. In contrast, owning a REIT mutual fund minimizes that risk while providing the diversification benefits of an entire asset class.

The same is true for international investing. While many foreign companies are listed on U.S. exchanges, not all companies or markets are represented. Investing directly in stocks listed on foreign exchanges, though, can present formidable challenges for investors.

Foreign-listed stocks offer all of the challenges and risks of normal domestic investing, plus a few extra ones. Simply finding a broker to handle the business is one hurdle, and even then, investors often have to contend with the difficulties in information flow, research, taxes, and the different foreign rules and regulations that international investing can present. As someone who used to work for an international hedge fund, I can tell you that it can be a real hassle.

So instead of searching for a broker that will let you trade shares in Botswana and spending your weekends tracking down press releases from Jordanian corporations, why not buy into a high-quality international fund such as OakmarkGlobal (OAKGX)? Oakmark Global holds 54 equity positions spanning more than 12 countries. The top 10 holdings (which make up 31% of the total portfolio) are:

Bottom line
Here at The Motley Fool, we take it as orthodoxy that individual investors can, with the right mind-set and strategy, outperform the markets on their own. But it is my opinion that this belief in no way conflicts with the notion that adding some high-quality mutual funds into the mix can improve performance.

Of course, not all funds are created equal, and not all funds are worth owning. In fact, the vast majority of funds aren't worth owning -- they're managed by run-of-the-mill caretaker types who can't beat the market and are more concerned with not losing (and losing customers) than winning.

And that's why we have Shannon Zimmerman and the Champion Funds team. They spend their time panning the river of mutual funds for those few golden nuggets that are worth owning -- and they do a good job of it.

By now, I've hopefully made my case for why even a stock junkie like me would and should own a mutual fund or two. It's a great way to dip your toes into a much wider investing ocean without the risk of losing a limb to Jaws' second cousin.

So to all of my fellow stock junkies out there, I say the following: Put away your spreadsheets for a moment, forget about discounted cash flow for just a little while, and take a 30-day free trial of our Champion Funds newsletter. You just might find the right fund to help you take your overall performance up a notch.

This article was originally published on July 20, 2005. It has been updated.

Fool contributor Stephen Simpson owns shares of the Dodge & Cox Income Fund but has no financial interest in any other stocks or funds mentioned (that means he's neither long nor short the shares). Dell is an Inside Value and Stock Advisor recommendation. BMW is a Stock Advisor recommendation. Diageo, GlaxoSmithKline, and Snap-on are Income Investor recommendations. The Motley Fool has adisclosure policy.