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.
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 service.
Diversification -- how they do the voodoo they do
I'm not speaking of diversification here as it's typically defined. It's old hat to say that mutual funds allow investors to diversify their investments; of course that's true. Most mutual funds own 100 or more stocks, which is certainly a more diversified portfolio than average investors could (or should) attempt on their own.
But all that diversification isn't necessarily a good thing. Once a portfolio reaches a certain size, its performance increasingly correlates with the overall market. Moreover, I often tend to agree with the more curmudgeonly investor types like Warren Buffett, who 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 growth story, perhaps the "next" Cisco Systems
And the reverse is also true. You might be a hard-core value hound and go to sleep with the Berkshire Hathaway annual report 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 shorting, for instance. Not many individual investors are comfortable shorting stocks, and you can certainly argue that the rules of the market discourage the practice. But it might be nice to own a fund like Prudent Bear or Grizzly Short if you believe the market is in for some real weakness, and/or you just want to diversify your approach.
That same rationale can be applied to many other sectors or asset classes, 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 biotech investing. Maybe you have a knack for spotting the next Amgen
So instead of spending your time poring over 10-K's and clinical research journals, why not consider a high-quality fund that invests in the sector (either exclusively or in part)? Buying the T.Rowe Price Health Sciences fund gets you exposure to stocks like Gilead Sciences
Here at The Motley Fool, we take it as orthodoxy that individual investors can, with the right mindset 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 not 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 Champion Funds. 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 has no financial interest in any stocks or funds mentioned (that means he's neither long nor short the shares). T. Rowe Price Health Sciences is a Champion Funds pick. The Fool has a disclosure policy.