Let's face it -- when it comes to investing, one size doesn't fit all. Investing in individual stocks isn't right for everyone, and even mutual funds may not be best for some. Here's a quick checklist to help you figure out where you stand.
Are you a decent stock evaluator? Do you know the difference between net and gross profit margins? Do you enjoy poring through balance sheets and income statements, or calculating returns on assets? If not, you might be better off with mutual funds than stocks.
Do you have plenty of time to study lots of companies, seeking the most promising ones? Once you buy into companies, are you prepared to keep up with them regularly, reading their quarterly and annual reports and ideally following them in the news, too? (For example, if you're a Netflix investor, you probably want to know that sales of mail-delivered DVDs seem to have peaked.) If not, mutual funds should look more attractive than stocks.
Decisiveness and follow-through
Are you good at deciding which stocks are the most compelling buys right now, and at taking action to buy them? Are you good at deciding when it's best to sell, and actually following through by selling? Many of us put off such decisions or have trouble making them. In that case, mutual funds can be best.
Do you want to double your money in a single year? If so, you probably won't swing that with a mutual fund, while a stock is much more likely to grow that fast. But it's still not that likely. For most companies, growth rates will likely be in the single digits or teens. The stock market has returned an average of around 10% annually, over long periods, and most mutual funds don't top that. Fortunately, though, there are plenty of funds that do top that performance, handily. The Fidelity Contrafund (FCNTX), for example, has averaged 16% per year over the past five years. It was recently invested in firms such as Hewlett-Packard
What to do
Take an honest look at yourself. Do you really belong in the arena of individual stock investors? Many of us don't, for one reason or another. I have plenty of stock investments, but I've recently been loading up on mutual funds. I realize now that there are some real gems out there in fundland, and that I can ride the coattails of some smart money managers. (I'm beginning to accept that seasoned professionals who study companies every day for a living are likely to perform better than I would.)
It's not necessarily an either-or situation. Consider parking most of your money in funds, but leaving a chunk devoted to some carefully selected individual stocks.
When you seek top-notch funds, find fund managers whose philosophies and styles appeal to you. Look for low fees, a lack of sales loads, low turnover, and strong track records. I've found some very promising funds for my own portfolio via our Motley Fool Champion Funds newsletter. Together, its picks have gained an average of 27%, vs. 13% for benchmark indices. Try it for free, and you'll be able to access all past issues and read about every recommendation.
This article was originally published on Nov. 6, 2007. It has been updated.
Longtime Fool contributor Selena Maranjian owns shares of no company mentioned in this article. She does own a few shares of Fidelity's Contrafund. Disney and Netflix are Motley Fool Stock Advisor recommendations. The Motley Fool isFools writing for Fools.