If you’ve been investing for any length of time, you’ve probably owned some mutual funds. And many wonder which is better — mutual funds vs individual stocks.
While first founded in 1924, the mass adoption of mutual funds in the 1980s was game-changing for individual investors. Mutual funds allowed the little guys to behave like the big guys — making pooled investments in diverse asset portfolios from multiple sectors and thousands of managers. But, mutual funds have real and costly disadvantages.
That’s why CSH prefers investing in individual securities (or individual stocks and bonds, rather than those pooled and managed by third parties).
Why Mutual Funds are Bad
In a previous blog post, I explained that mutual funds are “sold” to consumers. They are sold because mutual fund brokers have an incentive to sell them. Investing in mutual funds comes with a cost of 1.5-2% a year due to the sales charges, management, distribution, and shareholder fees. These charges are built into the mutual fund price and are largely hidden from the investor.
In addition to these costs, the advent of ETFs, or Exchange Traded Funds, in the 1990s made mutual funds structurally obsolete.
In short, savvy investors don’t buy mutual funds anymore.
Why ETFs are Better but not Perfect
ETFs hold fixed amounts of shares in many different stocks and investments. An ETF manager can buy and sell those stocks without you incurring capital gain. They can use in-kind transactions to avoid taxation. You’d only get a tax bill from an ETF if you decided to sell — the same as when you own an individual stock. While ETFs are an improvement over mutual funds, they can also have creeping fees and structural disadvantages. It’s not a perfect solution.
Why CSH Prefers Investing in Individual Securities
When we say “individual securities” we mean individual stocks and bonds that are not pooled and managed by third parties. We fundamentally believe that it is better for our clients if we invest in individual stocks and bonds. So, when it comes down to mutual funds vs stocks, it’s no contest. Here are 4 reasons why we prefer individual securities:
1. Individual security fees are straightforward and transparent.
Mutual fund fees are complex and always changing. I have always believed that all mutual fund fees — including commissions, management fees, and distribution fees — should be disclosed to the client. Unfortunately, they are not, and even if you’re aware that they exist, they are difficult to figure out.
With individual security investments, clients pay no hidden fund management fees, distribution fees, or commissions. At CSH, the only fee is our management fee, which is fully disclosed and transparent. You may incur a small transaction fee in rare cases, but they can typically be alleviated through free trades offered by custodians such as Schwab and TD Ameritrade.
2. Individual security risks are easily quantified.
Mutual funds and ETFs can own hundreds, if not thousands, of securities (stocks and bonds). On the surface, that might sound like a good strategy to reduce risk. In reality, it may conceal bad practices.
Consider the financial crisis of 2008. Millions of investors were steered toward CMO’s (collateralized mortgages) and other derivative-driven securities. Mortgages sounded safe and had very high yields. These CMO’s owned literally thousands of individual mortgages. It was nearly impossible to analyze such an investment. When these investments went bad, layers upon layers of subprime junk mortgages were discovered. In that case, greater numbers didn’t mean less risk.
With an individual stock or bond, you can easily view and analyze financial statements and quantify risk factors like debt and cash flow.
3. Individual security risks are understandable (i.e. more reality and less theory).
Mutual fund brokers like to show graphs and tables of how their investments reduce the risk of market volatility for you. This is a false exercise. That’s because they assume the volatility of the past will be the same in the future. What if it isn’t?
With individual securities, it is easy for me to quantify risk, which is the probability of losing all or part of the investment and never getting it back. Not so for constantly changing mutual funds or ETFs. They are always changing, so at any given time one has no idea.
4. Individual security investments and tax implications are managed by someone who cares about YOU.
If I invested in a mutual fund for you, I’d be turning over investment decisions about your money to a distant, uninvolved third party — someone who doesn’t know and care about you and who is driven by other motives. It is telling that mutual fund managers rarely invest themselves in the funds they manage.
CSH has no incentive whatsoever to recommend one individual stock or bond investment to you over another. We make it our business to monitor and know your tax situation in case we can take losses to offset gains and partake in tax swaps to harvest capital losses.
CSH simply looks for the best individual security opportunities to help meet your goals and that’s the way it should be.
CSH Can Analyze Individual Security Investments for You
When I left college, it seemed the only pathway to becoming a stock analyst was through New York. But the New York City stock analyst life wasn’t for me, so I took a different path. I honed my skills in investing and fundamental analysis as a side passion while I built my tax business.
I still love studying the economics and accounting of different sectors and companies! Let CSH put our analytical skills to work for you if we haven’t already.
If you are an existing CSH client and have questions or concerns about your account, we are always here to speak with you.
If you’re not an existing CSH client but have questions about mutual funds vs stocks or the mutual funds you’re currently invested in, please give us a call at 217-824-4211. We would be more than happy to speak to you about your current situation and analyze ways it could be better.
We are a fiduciary, and this means we always act with your best interest in mind!