I love stocks.
I do; I really love stocks. They're great investment vehicles -- data shows that stocks outperform all other equity classes over the long haul -- and they're fun to root for, research, and track (hopefully not in that order).
That said, I don't feel comfortable turning my entire portfolio over to individual stocks -- and it's OK if you don't, either. That's because funds and stocks can coexist in a portfolio like peanut butter and jelly.
Two of a kind
Are you properly diversified? Deep down, I'm guessing that many of you answered that question with a soft "no." To be properly diversified, you need exposure to all areas of the market, spanning asset classes, sectors, market capitalizations, countries .
The answer to that dilemma may well be mutual funds. Yes, mutual funds. With well-chosen funds, you can obtain instant diversification without a large cash requirement. Many funds will let you in the door with a minimum investment of $1,000, and some will reduce it even further for IRA accounts or for folks who commit to invest a set amount each month. Heck, if you play your cards right, you can even purchase a fund without a transaction fee. How's that for a deal?
Buy what you know .
Peter Lynch famously urged individual investors to invest in what they know. Just as important, though, is to know your limitations.
You might know the biotech industry very well. Perhaps you have educational or vocational experience in biotechnology. Maybe your parents were biochemists. Kudos to you if you can analyze drug pipelines and pharmaceutical potentials. But what do you know about real estate investment trusts? How about semi-regional banks?
The point is, if you only stick to what you know, you'll have a very, very concentrated portfolio with a ton of industry-specific risk. Unless your last name is Buffett or Munger, I'd steer clear of that.
Instant exposure
I, for one, feel pretty good about investing in mega caps such as Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) -- I own shares of both -- but that leaves my portfolio devoid of small caps. The problem is that I don't research small caps enough to feel comfortable investing in them. For fun, I took a look at the top 25 holdings of one of my favorite small-cap mutual funds, the now-closed Royce Premier (RYPRX). I recognized only a handful of names. And just because I recognized the names Winnebago (NYSE:WGO) and Polo Ralph Lauren (NYSE:RL) doesn't mean I'd feel confident investing in them.
I'm also outside my comfort zone with international equities and their varying standards of corporate governance. I know a few companies that offer American Depositary Receipts (ADRs) -- global auto behemoths Toyota (NYSE:TM) and Honda (NYSE:HMC) and big pharma Sanofi-Aventis (NYSE:SNY).
Problem is, buying shares of just one of these already global companies won't give me much exposure to emerging markets in South America or Asia. Further complicating matters, the costs associated with investing in companies that don't have ADRs can be prohibitive for individual investors like you and me.
An easy place to start would be funds. For your international exposure, for instance, you could let the international stock-picking specialists at Motley Fool Champion Funds recommendation Dodge & Cox International (DODFX) do the dirty work for you.
Price still matters
With funds as with stocks, though, price is paramount. Dodge & Cox International, for instance, has an expense ratio of merely 0.70% annually, a price -- as Bob Barker might say -- that is definitely right.
When it comes to mutual fund fees, I'm a complete cheapskate. As Champion Funds analyst Shannon Zimmerman always says, you most often get what you don't pay for. So screen out load funds or expense ratios greater than 1.5%. Most often, they're not worth your time, much less your money.
The Foolish bottom line
I am willing to pay for certain things in this world, and expertise and diversification are among them. With a core of well-selected mutual funds with management teams that are solid and fees and turnover that are kept in check, Fools like us can sleep well at night, letting someone else buy what they know.
If you want a cheat sheet to help get you started, Fool fund guru Shannon Zimmerman has found high-quality mutual funds with an average expense ratio of about 1% -- well below the industry average of 1.5%. You can see the more than 40 funds Shannon has recommended over the past two and a half years -- which are beating the S&P 500 by more than eight percentage points -- with a free 30-day trial. There's no obligation to stay if you're not fully satisfied. Click here for all the fine print.
Fool contributor Ryan Angell owns shares of Microsoft, Intel, Royce Premier, and Dodge & Cox International. Royce Premier and Dodge & Cox are Champion Funds recommendations.Intel and Microsoft are Inside Value recommendations.The Fool has a disclosure policy.
