Investors often feel passionate about what they invest in. If you generally prefer to invest in individual stocks, you may believe there's no reason for you ever to own any sort of fund. On the other hand, plenty of investors never choose to go beyond using mutual funds and ETFs as their primary investment vehicles, taking advantage of the diversification that funds provide even for those who don't have much money to invest.
But once you've gotten some investing experience, you'll find that sticking with only one method forces you to miss out on some advantages that each type of investment has. Fund investors can gain a lot from researching individual stocks. Conversely, in a number of situations, a good ETF or mutual fund can help stock investors in ways that would be just too impractical using individual stocks.
The benefits of individual stocks
Fund investing can be relatively simple and straightforward, allowing you to get exposure to a broad set of stocks while leaving the stock selection process to professionals. But if you're willing to do some extra research, owning individual stocks can help your results tremendously. Here are some things that in-depth research at the individual company level lets you do:
Find the cream of the crop. Drilling down into a particular company gives you insight not just on that company, but also on its entire network of competitors, suppliers, and customers. For instance, anyone looking at smartphone-maker Palm
(NASDAQ:PALM)will probably end up learning a lot about competitors Apple and Research In Motion, as well as Palm's relationship with data provider Sprint Nextel (NYSE:S)and component makers like Texas Instruments (NYSE:TXN)and Qualcomm (NASDAQ:QCOM). By gaining an intimate knowledge of companies in a particular industry, you can eliminate also-rans and focus on picking the best of the best.
- Dodge dicey management. Doing research means more than just poring through financial information. When you read through annual reports and listen to presentations to shareholders, you can get a feel for a company's executives and directors, and whether they'll stand up for your rights as a shareholder.
- Stay flexible. Often, you'll identify a couple of attractive stock ideas in a particular sector. If you only want to own one, you gain an easy backup plan: If some adverse event changes your mind about your top pick, you can just switch to your second-best choice without panicking.
Individual investing simply opens up a much broader range of choices for you to consider.
How funds can help
Nonetheless, funds have a place in your portfolio. Even for those who prefer to buy individual stocks, here are some situations in which you might decide to go with a mutual fund or ETF instead.
To diversify. Sometimes, researching a particular company will show that you really like the entire industry, but you're not sure which company will emerge as the industry leader. In that case, a sector ETF can give you a one-stop shopping opportunity.
For instance, say you believe that oil's recent rise is just the beginning of a much bigger long-term move. If you're not sure whether big oil companies like ExxonMobil
(NYSE:XOM)and ConocoPhillips (NYSE:COP)will reap more benefits than smaller independents like Range Resources (NYSE:RRC), then an ETF like the Energy Select Sector SPDR (XLE), whose portfolio includes all three stocks and many others, can let you cover all your bases.
- When you don't know an industry. No matter how experienced you are, stock research takes a lot of time and effort. If you think an industry is promising, but it's outside your circle of competence, buying a fund that covers that area can give you the exposure you want without a big time commitment.
Funds aren't just for people who don't have the ability to research individual stocks. Even expert stock investors can use funds profitably.
Don't limit yourself
In the end, there's no reason that you have to choose between being a fund investor or a stock investor. The smartest way to invest is to realize that both funds and individual stocks have their benefits and to use both to their maximum advantage. With the full arsenal of investing tools at your disposal, you'll have a better chance of achieving financial success.
Both funds and individual stocks can help you get rich, but which do you use more frequently in your investing? Please share your experiences in the comment box below.
Fool contributor Dan Caplinger has an even mix of funds and individual stocks. He doesn't own shares of the companies mentioned in this article. Apple is a Motley Fool Stock Advisor recommendation. Sprint Nextel is an Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy offers it all.