Many stockbrokerage firms had record earnings in 1993. The bulk of stockbrokerage firms' revenues comes from securities transactions, which means a lot of investors were buying and selling a lot of individual stocks and bonds. This article is written for those of you who prefer individual stocks over diversified mutual funds or as a congratulatory pat on the back for those of you savvy enough to have jumped on the no-load mutual fund bandwagon.
WHY BUY INDIVIDUAL STOCKS? Investing in individual stocks can be exciting. The thought of finding one of Peter Lynch's "10 baggers" or otherwise getting rich quickly is one of the major allures of individual stocks. Individual stocks can also be comforting in that you are invested in a real company instead of a ever-changing basket of stocks in a mutual fund.Brokers like to point out that individual stocks allow you the ability to control your capital gains, whereas mutual funds generally pay out capital gains each year whether you want them or not. What brokers don't tell you is that they have a vested interest in encouraging transactions that generate commission income for them.
Whatever your reasons for buying individual stocks, I believe that mutual funds, particularly no-loads, are superior vehicles for individual investors. Why?
1. DIVERSIFICATION. Investors with less than $200,000 will find it difficult and expensive to build an adequately diversified portfolio of stocks. Most academic studies show that investors need 15 to 25 stocks to achieve reasonable diversification.
2. LOW COST. No-load mutual funds are the perfect example of financial democracy in action. The smallest investor pays the same fee as a large investor and each receives equal treatment (returns). Overall, the average equity fund charges about 1.3 percent annually, far cheaper than the cost of buying and selling stocks on your own.
3. SUPERIOR RETURNS. Individual stocks offer the opportunity to hit a home run but over a long period of time. However, A diversified mutual fund should earn more money. More importantly, I highly doubt that your broker (read commissioned salesperson) is smarter than a professional mutual fund portfolio manager.
To prove my point, the below chart, courtesy of Pioneer Funds, lists the performance (dividends included) of the 30 stocks that make up the Dow Jones Average over the last 20 years. These are the bluest of the blue chips and you see that investing in established companies is no guarantee of profits.
WHAT $10,000 GREW TO Jan. 1, 1974 TO Dec. 31, 1993
Company Value Company Value
Boeing $1,044,244 Texaco $103,087
20th Century Growth $391,117 Proctor & Gamble $98,230
20th Century Select $327,580 J.P. Morgan $97,265
United Technology $240,891 General Motors $97,169
Exxon $193,287 Du Pont $71,327
Walt Disney $191,910 Allied Signal $61,721
AT&T $181,277 Aluminum Co of Amer $60,123
Coca-Cola $179,069 3M $58,054
Goodyear Tire $166,631 Intl Paper $57,843
Woolworth $162,109 Westinghouse $57,324
Chevron $155,813 American Express $55,628
General Electric $141,007 Sears Roebuck $45,674
Merck & Co $128,928 Caterpillar $33,665
Union Carbide $124,985 Cost of Living $25,094
McDonalds $123,363 Eastman Kodak $25,094
S&P 500 $109,847 IBM $20,452
Dow Jones $109,458 Bethlehem Steel $12,601
Source: The Pioneer Group
You might have noticed that I slipped in the Cost of Living and Dow Jones Industrial index along with the performance of two well known no-load mutual funds - 20th Century Growth and 20th Century Select.
I chose the 20th Century funds as an example because of their excellent long-term performance, but there are many other funds with similar track records. (For a free list of my current no-load recommendations, call 800-445-5900.) Surprisingly, only one stock, Boeing, beat the performance of the two 20th Century funds. The remaining 29 Dow Jones components all underperformed, some significantly.
KEEPING UP WITH THE JONES. In fact, three stocks (IBM, Eastman Kodak and Bethlehem Steel) didn't even keep pace with inflation. Sixteen of the 30 underperformed both the Dow Jones Industrial Average and the S&P 500.
The point is that selecting winning individual stocks is tough. Even the most respected companies in America have trouble outperforming well-managed mutual funds. The chances of a commissioned salesperson being a better stock selector than a professional portfolio manager are slim to none.
CAN YOU FIND THE NEXT BOEING? Investing in individual stocks is both an expensive and difficult game to play. Two obstacles stand in your way. One, the transaction costs of buying and selling stocks and two, the dubious advice handed out by commissioned salespeople.
Do you really think a broker would let you sit on a stock that had tripled, quadrupled or more in value? Of course not. He or she only gets paid upon a transaction so they have a vested interest in moving your money from one stock to another. Mutual fund managers, conversely, often hold on to winning positions for years and years, multiplying their profits.
Individual stocks are sexy, exciting and offer big rewards. Mutual funds may be boring - all the way to the bank.