Taking the first step

Although it is known that in the longer term, the stock market usually does better than other types of investment; many investors fail to capitalize on this opportunity for reasons such as fear, lack of time and resources. In more developed countries solutions have been fashioned to facilitate the entry of more investors into the equity markets. These solutions have been very effective, as according to the Investment Company Institute (ICI) 49.5% (or 52.7 million) of U.S. Households owned equities in some way shape or form in 2008. However, only 21 million (less than 20%) owned individual stocks. The ICI is a national association of U.S. investment companies including mutual funds, closed end funds, exchange traded funds (ETFs) and Unit Investment Trusts. These are some of the solutions which have enabled investors to take the first step. Today, we will be concentrating on mutual funds.

A mutual fund is a professionally managed type of collective investment scheme that pools money from many individuals for investment in bonds, short-term money market instruments, and/or other securities. Since formation, mutual funds have been a popular investment vehicle, giving investors the ability to take their first step into the stock market because of their ease and features which provide great benefits to investors with limited time or money.

Overcoming fear

No-one, not even experienced investors and wealth managers, can predict with certainty which way a stock market will go. Taking the U.S. equity market into consideration, some analysts use recent economic data to indicate that the worst of the global financial crisis is over and stock prices will rise; while others think the problems in some European countries could send markets down again. No matter what period of history you examine there will always be conflicting reasons which could drive the markets up or down. Even if all indications are positive and the bulls are raging, the bears will say that stock prices are too high and its time for a correction. That is why one rule of investing, for both large and small investors, is diversification. Diversification is simply a method of reducing risk by investing in a variety of assets. For the individual investor, buying a variety of assets can be quite costly. By purchasing mutual funds, you are provided with the immediate benefit of instant diversification and asset allocation without the large amounts of cash needed to create individual portfolios. Don’t just buy one mutual fund and ensure you buy funds in several sectors. For example, investing in an energy mutual fund might spread your money over fifty companies, but if energy prices fall, your portfolio will likely suffer, so you may want to buy two mutual funds one in the energy sector and the other in the financial sector. This takes me to the next reason many individuals don’t take the first step, lack of resources.

Overcoming lack of resources

Imagine if you wanted to buy more than four stocks in order to create a diversified portfolio. The commission charges alone would eat up a good chunk of your amount available for investment. Add to this the fact that you would have to pay more transaction fees every time you wanted to modify your portfolio – as you can see the costs begin to add up. With mutual funds, you can instantly own a variety of stocks in different sectors in just a few transactions, depending on how many mutual funds you buy. So if you want to have a diversified portfolio comprising energy, gold and health sciences stocks, that could be done in two transactions by investing in a energy and gold sector mutual fund such as the CI Signature Canadian Resource Corporate Class Fund, and a health sciences mutual fund such as the CI Global Health Sciences Corporate Class mutual fund. So we have overcome fear and lack of resources, all that is left is lack of time.

Overcoming lack of time

Time is perhaps the most precious commodity of all, and you will need to educate yourself on the different aspects of the stock market. Once you have grasped the basics, then comes the research you will have to do on each investment. If only you had someone to do thorough research and carefully select the best stocks, so that you would not have to spend enormous amount of time doing it yourself. Fortunately mutual funds provide that service. When you buy a mutual fund, you are also choosing a professional manager. This manager will use the money that you invest to buy and sell stocks that he or she has carefully researched. Therefore, rather than having to thoroughly research every investment before you decide to buy or sell, you have a mutual fund’s money manager to handle it for you.

Conclusion

As with any investment, there are risks involved in buying mutual funds. These investment vehicles can experience market fluctuations and sometimes provide returns below the overall market. Also, the advantages gained from mutual funds are not free: many of them carry loads, annual expense fees and penalties for early withdrawal. However they provide the diversification, economies of scale and professional management which investors can use to take the first step into the equity markets.

Deon McLennon is an Equity Trader at Stocks & Securities Ltd. You can contact him at dmclennon@sslinvest.com.