Why do the "experts" on the business shows keep suggesting people buy mutual funds instead of individual stocks? To the contrary Tobin Smith recently said, "I never met anyone that got rich buying mutual funds, but plenty that got rich buying stocks." — Terry Johns, Kuwait City
Building a portfolio of stocks requires a significant investment in time and effort — and many investors don’t have the time necessary to do it well. That is where mutual funds come in. A mutual fund manager builds the portfolio for you for a fee. The manager lessens your risk through diversification so any potential disaster is minimized because you have spread your risk amongst many stocks. The problem lies in that he/she may be no better than you in building a portfolio, and may only provide a mediocre return.
Buying individual stocks is the riskiest — and potentially most rewarding way — to invest in the stock market. Owning individual stocks can be a bonanza, as one or two stocks could hit a “home run” for you. But it could also be a disaster as you may own a bomb that sinks your entire portfolio. You would have to watch the market very closely, with very “hands-on” approach to be able to ensure a good return.
There is now a third choice between individual stocks and funds — the Exchange Traded Fund, or ETFs. They are a very low cost and liquid way to own a diversified basket of stocks in most any given sector. Information on the universe of ETFs is readily available on finance.yahoo.com/etf.
The bottom line is that if you can watch the market all day like the pros then trading and investing in individual stocks can provides a great reward, albeit with significant risk, depending on your trades. Mutual funds can be expensive and only provide mediocre returns, but will lessen your risk while affording you a “hands-off” investing experience. ETF’s combine the best of both worlds, for both near-term trading and longer-term investing.
Hi, I have a lot of dividend stocks, i.e.., PAA, PGH, NZT, utilities, etc. They have done very well this last year in particular. How will higher interest rates affect them? Thank you. — Diane (Lake Oswego, OR)
Higher interest rates are generally not good for stock investments. As rates rise the economy slows and there is a higher cost of capital for investment. But in the case of utility stocks, the reason is competition. If interest rates move higher, then investors can get the same or better return on their investment by buying government bonds that have essentially no risk.
Very low interest rates and the cut in capital gains taxes have made safe, dividend-producing stocks more attractive. But that has made utility companies trade at a higher valuation and offer a lower yield than the historic norm. As the interest rates paid on guaranteed government bonds rises, it makes other dividend-paying stocks, including utilities, less attractive.
What is the relationship between the stock market and the bond market? Of all the financial markets (NASDAQ, Dow Jones, etc) which one has performed better? —Curt (Jackson, MS)
The answer to the first part of your question is similar to the answer outlined in the previous question. When interest rates are very low, the return from investing in bonds is generally lower than compared to stocks. But, when rates rise, they can provide a virtually riskless alternative for investor’s dollars. Investors will place a larger allocation of capital where a good return is guaranteed — like in government bonds — and that means less capital for stock investing. So, there is usually an inverse relationship between the bond and stock markets.
When comparing the Dow 30 to the Nasdaq Composite, the relationship has been consistent over the past few years. Both tend to move up and down together, but because the Nasdaq contains more growth-oriented companies that are riskier and more volatile, it moves both up and down in a larger percentage than the Dow 30. For example, in the down year of 2002, the DOW was down 18%, but Nasdaq was down 32%. In the up year of 2003, the DOW was up 24%, but the Nasdaq was up 46%. The bottom line is that Nasdaq usually will do better in an up market and worse in a down one. So you can say that when the Nasdaq is up it is very, very good, but when it is down it is horrid.
I like Jim Rogers' idea about small utilities. Could you give me the names of some of these smaller utilities? Thanks — Vhehn
What Jim was referring to was the repeal of the Public Utility Holding Company Act of 1935 (PUHCA). This law was one of the last major holdovers from the depression-era New Deal legislation. This act limited and restricted the growth and expansion of electric and gas utility holding companies by confining their operations to discrete geographical areas, and from owning other businesses that are not related to the utility business. It also discouraged ownership of gas and electric utilities by domestic industrial and financial institutions and by foreign institutions. The repeal of this law paves the way for mergers and acquisitions in the sector. Warren Buffet has already publicly stated that he would invest up to $15 billion in acquisitions in this sector.
As far as giving you names of these smaller utilities, there are at least 100 domestic electric and gas utility companies with a market value greater than $500 million and less than $20 billion. You should start your research by first finding the names of the companies: biz.yahoo.com/p/9conameu.html. There you will find every publicly traded stock in the sector.
With acquisition-hampering federal regulations out of the way, it sure seems that this is a ripe area for takeover activity. But remember, you should never buy a stock because you think it will be the recipient of a takeover attempt. Do your research and buy a good company first and foremost.
Being that the entire world seems to be more focused on security, are shares in security companies a good investment? I haven't heard much talk about these companies, which surprises me considering the ramp-up in safety measures. Could you give me the names of some of the better ones? — March (Chester, PA)
Homeland security companies have become a new industry sector since 9/11, but they are usually an offshoot of defense stocks. It is an area of dramatic growth and of very volatile stocks. Many of these companies are considered micro-cap — being under $500 million in market value — and I am precluded from mentioning them here as they may be too speculative and volatile. But there are many sub-sectors that encompass this area and a few are: cyber-security, explosive and bio-detection, smartcard and biometric ID, and video surveillance. Also, the big-cap defense companies are involved in homeland security, but they generally are not “pure plays.” My favorite mid-cap defense / homeland security company is L3 Communications Holdings Inc. (LLL). A good place to start your research is: biz.yahoo.com/p/6conameu.html.