Which is better: funds or individual stocks and bonds?
By ATB Wealth 2 October 2018 3 min read
For new investors, the world of stocks, bonds and mutual funds can be a confusing place. What’s the difference between them? And which ones are right for you?
Kimberley Walker, Wealth Relationship Manager at ATB Investment Management, explains how these different investments work and how to choose the best ones based on personal circumstances.
What are individual stocks and bonds?
“When you invest in an individual stock, you’re buying shares in just one company,” Walker explains. “If the company performs well, you’ll profit from it, but if it does really badly, you could lose your investment.”
Bonds, which are loans to a company or a government, are more stable and provide regular interest payments, but with typically lower returns.
“Bonds are meant to protect your capital when stocks are falling,” says Walker. “But for new investors, it can be very difficult to know which ones you should buy.”
The trick is to have a portfolio (a combination) of both stocks and bonds that will create growth with an acceptable level of risk.
The stress and cost of doing it yourself
“If you only buy one or two stocks or bonds, you’re putting all of your eggs in one basket,” says Walker. “To reduce risk, ideally you would want a minimum of 30 individual positions in a variety of industries and regions.”
“That’s a lot to manage,” she continues. “You would need to research each company, study financial reports and monitor performance.”
New investors can also become fixated on share prices and become tempted to buy and sell too often. This can be stressful and costly.
“Stocks typically have an equity trading fee,” says Walker. “The more you trade, the less you earn.”
Thankfully, there is a more efficient and less stressful way to invest in the stock market.
Letting the experts invest for you
“Mutual funds are managed portfolios of stocks and bonds that people can invest in,” explains Walker. “Fund managers research the companies for you, giving you access to a diversified portfolio without having to buy stocks and bonds individually.”
“If you only have one stock and it doesn’t perform well, you lose money,” continues Walker. “With a mutual fund, gains usually offset losses. With funds you’re not as exposed to individual company risk, as you are with single stocks.”
Investments in mutual funds can start as low as $100.
Finding your risk comfort-zone
Mutual funds cater to all levels of risk; with more bonds in the mix you typically get lower risk and lower return. With a larger ratio of stocks, there is a higher risk and potentially higher return.
“There is no free lunch,” says Walker, “you need to take some risk if you want to really grow your retirement savings.”
Young investors can afford to invest in higher risk funds as they have many years ahead to ride out any volatility in the market. People closer to retirement should be investing in more conservative funds.
“The ultimate goal is to be consistent and remain invested,” says Walker. “If it scares you to see your portfolio decline, be more conservative. But if sudden drops in value don't stress you, consider a higher risk fund.”
What to watch out for in mutual funds
“Look under the hood of the fund you’re buying,” advises Walker. “You want stocks in multiple industries and regions. If your fund is energy-heavy and energy falls apart, your investment falls apart. A diverse fund gets you through volatility.”
Also, be aware of management fees, which can vary considerably. “Funds that have higher fees will erode your ability to earn long-term capital,” says Walker.
Buy the haystack, not the needle
“When starting out, keep it simple,” says Walker. “With a well-diversified fund, you’re buying the haystack, not the needle. You’re looking to get the best return for the least risk.”
It’s also important to start investing early. “Even small contributions, made regularly, will help you to take advantage of compounding interest over a long period of time,” says Walker.
To discuss which mutual funds might be right for you, speak to an ATB Financial advisor.