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Why Invest in Mutual Funds

It is easy to understand why people would invest in mutual funds, but is it really a smart play? I would say the majority of investors select mutual funds because a) it is easy b) they think the professionals must be able to do better than them c) only option in their company’s 401K. Now there isn’t anything you can do about a company not offering self directed accounts, but most investors even given the option would go mutual funds over selecting stocks themselves. To compound the problem, the majority of investors select the top returning mutual funds from the previous year when they select one. If a mutual fund they own is doing poorly, they will drop that one and take the highest returning fund in their pool of funds. Statistics prove that this strategy will not beat the SP500 over the long haul.

There is no doubt that there plenty of good mutual funds out there; in fact there are some great ones. The problem is the majority of investors are not in these funds. I’ve read multiple articles with various stats on how many mutual funds actually beat the SP500 year over year. These numbers generally are between 10 and 20 percent, which is a staggering number if you think about it. Why would you want to park your money in a fund that isn’t beating the indexes on a consistent basis? Why not just pick an index fund and avoid the fees.

Does anyone like paying fees? I know I don’t and mutual funds charge you fees to run your account. They generally run between 1 and 2 percent, which may not sound like much but it can add up in a hurry. If you started with $10,000 and earned a compounded return rate of 7% in 20 years it would be $38,697. Now lets say with that same starting figure you earn 8.5% (1.5% increase from above), your new total after 20 years would be $51,120. Now doesn’t that extra money in your wallet/purse look nice just by avoiding fees!

If you have a fund that isn’t performing well, we can assume the manager of the fund will likely swap in and out of winners and losers he or she is holding. They undoubtedly will not sit on their hands and watch their stock selections circle the drain. This movement in stocks is music to the ears of the brokerage firms that has their account. They are collecting transactions fees for every stock they get in and out of. Who do you think is paying for that?

Okay this is all fine and dandy but you don’t have the time to pick stocks. It doesn’t take as much time as you think with stock screeners and the amount of information on the internet these days. Now there are hundreds of different approaches to investing in stocks, so I won’t get into which way is the best. You know your risk tolerance and can select stocks off that. If you don’t trust yourself picking stocks you can select stocks that the dependable investors like Warren Buffett or Carl Icahn select. You can even find several mutual funds that have historically beat the market over the years and look at their top 10 holdings. If they are in these stocks and have traditionally beat the major indexes, then they most likely are pretty good stocks.

The key to making your stock picks work for you is staying diversified. To what level of diversification should you have your portfolio setup? That again depends on your risk tolerance, but keeping your stocks spread out amongst the different sectors is a good way to avoid heavy losses. If you spent a little time researching stocks, you will see it is time well spent in most cases.

I know selecting stocks can be a scary process for a lot of people but at the very least aren’t you better off in an index fund with no fees. When I am working on my portfolio I have my best interest in mind and I’m not sure that always happens when other people are playing with your money. As an exercise, it might be a good idea to write down stocks you are thinking of buying and track how they are doing compared to your mutual fund. What do you have to lose except the fees?

Protective Puts for a Little Defense

With the stock market as volatile as it is right now, you have to think about ways to protect your portfolio. Many investors do not play with options and they can be confusing. They do however present a great way to protect gains on stocks you hold, or protect you from large losses. It is really an insurance policy on your portfolio. There are of course many strategies and different kinds of options to purchase or write, but I will talk about protective and married puts.

It can be difficult to sell stocks that have pulled in some nice profits for you. We have all done it: stayed with a stock after it was up a significant amount only to watch it start to nosedive until you are now sitting with a loss. We get an emotional attachment to a stock that has, over a period of time, performed well and just do not want to part with it. Protective puts, after a nice run, is a great insurance policy to make sure you do not follow the descent into negative territory. This protective put can also shelter you against quick drops on bad news that you do not have time to get out of, such as a poor earnings report.

This is just an example and each individual has to look at their own risk tolerance to figure out how they want to play this. If you own 100 shares of stock ABC and it is up 25% but you are a little worried about the state of the stock market, then it might be wise to purchase one put (which equals 100 shares) with the strike price, maybe around the 20% gain level or whatever level you want to set it at. This way you continue to hold the stock without worrying about a one-day event or holding the stock too long. You can guarantee yourself a nice profit with a protective put.

Another scenario could be you want to buy a stock, but at the same time want an insurance policy to protect you against a big loss. This is called a married put and is basically the same thing as a protective put. Again, this is only an example, but say you like company ABC and want to purchase 100 shares. The stock market has been volatile lately so you are a little worried about which way the market is going. You can purchase one put (which is equal to 100 shares) with a strike price below the purchase price. You will have to determine how much you are willing to stomach in losses to determine the strike price. This will not lock in a winner but does save you from big losses.

There are many ways to play options and this is just a rudimentary explanation of how options can work for you. If you want more details on how to get options to work for you, contact your broker or you can check out the Options Industry Council’s web site at http://www.optionseducation.org. There are plenty of other web sites that can give you options help, but this one is my favorites.