I was listening to Paul Winkler Saturday in the car. Mr. Winkler is an investment advisor who calls himself an “investment coach” and has a radio show called “The Investment Coaching Show.” He has a lot of great advice and any who are able to listen to his show (which I guess is everyone, given podcasts and iHeart Radio and all, should do so.
Mr. Winkler advises listeners to invest only in mutual funds and to spread out funds to achieve as much diversification as possible. This means putting money into US large caps and small caps, bonds, and also into international stocks. I’m not certain if he advises investing in real estate through REITs or REIT mutual funds or making other investments, but having exposure beyond the stock and bond market would provide more diversification. Real estate and stocks do not normally trend int he same directions at any given time, 2008 aside.
One point that he was making Saturday is that it makes no sense to invest in individual stocks because the risk is much higher and the rate of return, if things go well, is about the same. There is some good wisdom in this, since most people who invest in individual stocks tend to lag the market indices. I would also say that if you have no desire to make investing your hobby, there would be nothing wrong with just dropping your money in a set of mutual funds and rebalance them a once a year or so and be done with it.
If someone were to hand me a million dollars, I certainly would stick at least half of it in a set of index mutual funds. I know that if I did so the money would be protected from both inflation and the type of losses that were possible with individual stocks, and I would receive a decent return from my investment. I would probably call up Vanguard and put one-third each in a large cap fund, a small cap fund, and a mid cap fund. I might also add an international fund and maybe a growth fund and a value fund. I would probably take the rest, however, and put it into a set of carefully chosen stocks.
The reason is that there are people who do beat the market by substantial margins by buying individual stocks. They are certainly not the norm, but there are enough of them out there to show that it is not just a fluke. The reason is that while the return of a randomly chosen basket of stocks will follow the market return, there are companies that over long periods of time grow substantially faster that others. These are companies like Microsoft, Intel, IBM, Home Depot, Procter and Gamble, GE, Exxon, and Berkshire Hathaway.
These companies are not a buy-and-hold forever investment like mutual funds would be. Certainly, most of the names on that list have been poor investments over the last several years since they have grown largely to their potential and have started to decline somewhat as rivals emerge or technology changes. Even if they have not declined, many of them have at least started to tread water. If one had bought a few hundred shares worth of any one of them fairly early in their life-cycle and held them while they grew, however, one would have done significantly better than the market indices and would have become a multi-millionaire.
So Mr. Winkler is absolutely right that investors should diversify their holdings, particularly when they have enough money to protect. Savings for things like retirement should also be well diversified to ensure that at least the market return will be gained. Mutual funds are an excellent way to do this, and the primary things to consider when buying mutual funds is that the expenses are low and the diversification provided by the mutual funds you hold is sufficient. Having some of your money invested in a few choice companies that have a good potential to beat the markets and dominate the industry in ten or twenty years, however, is also something many investors should consider.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.