Boasting about mutual funds certainly doesn't make for spicy chatter on the golf course. Yet, people would gladly blow a birdie than miss a story about an Internet stock conquest.
While mutual funds lack sex appeal, experts advise average investors to stick with them and fight the temptation to pick stocks on their own.
"Too many people don't have the time, the inclination or the intelligence [to select stocks]," said Thomas Grzymala, president of Alexandria Financial Associates Ltd. "It is a lot easier to pick a good fund manager and let them do the grunt work."
There are a number of reasons that experts favor mutual funds over individual stocks:
Mutual funds offer investors broad diversification. Because the money is spread among many stocks, they are less risky.
The money is managed by professional managers.
Shares can readily be bought and sold, unlike some small company stocks.
The fund's strategy is typically easy to understand after reading the prospectus.
Mutual funds have become a big hit among investors as more people are taking control of their finances, and companies are offering 401(k) retirement plans, which often allow employees to direct money into mutual funds.
The industry has exploded during the 1990s with more than 77 million people investing in mutual funds in 1998, according to the Investment Company Institute, a trade organization in Washington. Total assets have zoomed to more than $6 trillion as of July 30, from $1.067 trillion in 1990.
But while the popularity of mutual funds has soared, there are times when it is appropriate to invest in individual stocks, experts say.
John Markese, president of the American Association of Individual Investors, a nonprofit organization in Chicago with 180,000 members, said buying individual stocks is a way for investors to control capital gains costs.
Because mutual funds actively trade stocks during a year, fund holders must pay taxes on any capital gains their funds earned. But holders of individual stocks defer taxes on their appreciation until they actually sell the shares.
In addition, investors in individual stocks know exactly what is in their portfolio. In contrast, a mutual fund manager buys and sell stocks without investors' knowledge, so they never know exactly what is in the portfolio on a given day. "When you are in control, that won't happen," Markese said.
Individual stocks also can give investors more bang for their buck.
Of 3,237 U.S. diversified mutual funds -- funds that invest in more than 25 stocks in a variety of industries -- just 564 last year beat the Standard & Poor's 500 stock index, which is the benchmark used to gauge how well managers perform, according to Morningstar Inc., the mutual fund rating firm in Chicago. (On the other hand, just 594 funds in the same universe lost money.)
Until 18 months ago, Grzymala, who manages $45 million, was investing his clients' money strictly in mutual funds. But then he realized that he could boost clients' returns by investing some of their money in individual stocks, specifically in large, well-known companies.
"We keep track of our favorite 50 [stocks] and we watch them like hawks," he said. Favorites include Cisco Systems Inc., Gillette Co., Pfizer Inc. and Dell Computer Corp.
Investors who strike out on their own should diversify by building a portfolio of 10 to 20 stocks spread out among various industries, such as retail, computers, cyclicals and health care, Markese said.
"What a lot of people do is they tend to concentrate," he warned.
They also eagerly take tips from their friends or relatives and buy a stock without even knowing what the company does.
"If you don't have the knowledge, or the time and energy, to buy individual stocks, buy mutual funds," he said.
If an investor has the time, Markese recommends investing in small and mid-size companies where the chances of finding a gem are better than simply following the crowd and buying blue-chip stocks.
"There is probably more reward for the effort," he said.
Robert F. Mewshaw, president of Van Sant and Mewshaw, a Lutherville money management firm, says most investors are much better off with mutual funds.
"Stocks have much more risk in them," he said. "What they [investors] are really saying is, 'I am willing to take higher risk to get a higher return.' What they are really getting is higher volatility."
It is easy to get burned investing in individual stocks, too. Mewshaw draws an analogy to his college years when he went to the horse races and won big his first time out.
"That was the worst thing I could have done," he said. "I thought I was a handicapper. I thought I was going to finance my college education going to Pimlico. I ended up losing my shirt."
The same thing can happen to investors playing stocks, he said.
"Most people get confused with their own investment genius in a bull market," he said.
Pub Date: 10/03/99