Fund investing and stock investing
The world's oldest collective fund, Foreign & Colonial IT (FCIT), started in 1868. It was set up to enable people to spread their "investment over a number of stocks."
The Economist magazine stated that it "promises great gains without risk...In our judgement, the idea is very good." The investor today has the choice of active or passive funds as well as different fund structures:
Advantages of funds
- Diversification: By buying a fund an investor can be instantly diversified across a basket of stocks.
- Risk: Diversification is said to be the only free lunch in investing. Owning a basket of stocks reduces the impact of any single one of them failing.
- Cost: A fund is able to achieve economies of scale and reduce costs. This is not least with regard to buying and selling shares.
- Management: An active portfolio needs to be managed with large positions trimmed back and weak holdings cut.
- Themes and asset allocation: Exposure to both can be achieved quickly and at low cost.
Debunking fund myths
- Funds are expensive: Passive funds are cheap and fees for active funds have declined.
- Funds always underperform: Passive funds will inevitably come close to matching the index.
- It is impossible to pick active funds: The best performing funds share some similar traits.
- You either invest in funds or stocks: Having one doesn't mean not having the other.
Disadvantages of stock investing
- Diversification: An investor would need to buy at least 20 stocks to be diversified or 40 for small companies.
- International Investing: This is fairly costly to do directly and can be impossible.
- Theme investing: buying stocks in an area like healthcare or technology can be very challenging.
- Time involved: managing a 20 stock portfolio is likely to be very time consuming.
- Stock selection & monitoring: Meeting management and assessing the competition is also time consuming.
- Research costs: Software packages start from £225 a year and can run up to £600. Publications are also expensive.
The potential of stock investing
It is possible to do well as a direct investor and many private investors achieve this. However, they generally adopt an approach that is part trading driven. The means that they cut positions if the price falls below a certain threshold. This can be psychologically difficult for many people to do.
To do well investing in stocks you need to have a passion for it, the aptitude for it and a reasonable amount of time. Most people don't have all three of these factors at the same time.
There is a case for buying individual stocks if you believe you have a strong insight into a business. However, for most people it is advisable for stocks to only be a small part of a portfolio.
My view
"With fund investing you can build an international portfolio at a relatively low cost. You can also take a view on certain investment sectors such as healthcare or technology. Fund investing also allows you to significantly reduce your risk. A private investor may have built up a 20 stock portfolio that is exposed to the same risk factor."
