Table of Contents
Abstract
Investments make an individual feel intimidated by the technical terms involved, scared of making a mistake with their decision and overwhelmed by all the options available. In the United States of America, the puzzle about the best investment options troubles many as just like in any other developed nation, retirement signifies the end of receiving regular income for many people. In fact, the situation is so serious that unless a person makes the best decision, once they retire they have to continue offering consultancy services to continue receiving income. Hence, this is why, by the age of 35 years, people start thinking about making sound investment plans that will ensure that they pay tax and still manage a regular check every now and then to maintain their lifestyle. This paper examines the bog challenge facing retirees in US and across the world and compares the two main options, mutual funds and stock market. The aim is to reveal which option is better compared to the other one and why. The conclusion shows that its never a question of either stocks or mutual funds. The choice is always depended on the financial goals of an individual, their age, their times, and plans for the future.
Introduction
Thinking about investments makes an individual feel intimidated by the technical terms involved, scared of making a mistake with their decision and overwhelmed by all the options available. While referring to the naivety of the individuals seeking investment options across the world, Philip Fisher once said, “The stock market is filed with individuals who know the price of everything, but the value of nothing”. This testament suggested that one has to make sure before making a wise decision about their investment plans; they have to ensure that they are educated in the field and do research (Financial Markets and Institutions, 2005). In the United States of America, the puzzle about the best investment options troubles many as just like in any other developed nation, retirement signifies the end of receiving regular income for many people. In fact, the situation is so serious that unless a person makes the best decision, once they retire they have to continue offering consultancy services to continue receiving income. Hence, this is why, by the age of 35 years, people start thinking about making sound investment plans that will ensure that they pay tax and still manage a regular check every now and then to maintain their lifestyle (Atack, 2010). In this paper, the researcher understands the bog challenge facing retirees in US and across the world and therefore, in discussing the aspect of retirement in the US financial market, compares two main options, mutual funds and stock market. The aim is to reveal which option is better compared to the other one and why.
Literature Review
A retirement plan is the arrangement an individual makes to secure their financial situation once they are unemployed. Sometimes, the plans are laid out by the employers, insurance companies, unions, or individuals themselves. Depending on the plan laid out, an individual can get varied benefits or incur a loss for making poor decisions. Some of the plans include mutual funds, savings schemes, stock market, fixed deposits, or real estate among others. This paper focuses on mutual funds and stock market. A mutual fund is an investment strategy that is very common in the 21st century (Howells, Bain, & Dawsonera, 2007). As a security, this plan allows shareholders to pool their finances together to be managed by a professional manager. This money can be invested in cash, assets, bonds, or stock. The main benefit of the mutual funds is that the investor is allowed to receive returns on the chosen segment of the market; this is regardless of the fact that they own no individual stocks or bond in it. However, like any other investment, this plan has got disadvantages. The money is subject to depreciation but in using an asset allocation model to build a portfolio, an individual is able to determine how much their money should be in stocks compared to bonds (Madura, 2009).
On the other hand, the stock market is the place where public companies list their shares for trading and investments buy so that the firms can raise capital. There is a primary and a secondary market. The primary stock market is where an initial public offer for raising the capital is floated in form of shares and their prices. Once these shares are sold, they are later traded in the secondary market where those initial investors sell their shares to the fellow investors at the price they agree upon or at the prevailing market price. All this is carried out under the regulations of an authority (Groz, 2009).
Mutual funds and stock market investment plans are good options, but depending on how much risk or returns an individual is ready to handle, the choice is bound to vary. This is because the higher returns you expect, the higher the risk of investment. The choice of investment plan between the two is also depended on the time one has to learn and research about the firms involved. Case in point, it takes some time to study the stocks of a company before buying them from the market but less time is needed for an individual to get the mutual funds that are associated with the given company (Atack, 2010).
In any case, according to Atack (2010), investing in the stock market is riskier than in mutual funds. This is because for starters, mutual funds involve funds that pool in lots of stocks and bonds an aspect that leads to reduced risks. If a poor professional manager of the mutual funds causes loss or that the firm runs into a bad luck, the loss is cancelled or reduced by the profits from the other firms that have happened to perform well. Therefore, an investor does not end up with nothing like it can be the case in stock market. The main challenge with mutual funds is that an individual never really knows what to expect as a change in the professional manager of the mutual funds could result in drastic change in the returns. This is with regards to the annual management fees and the performance of the investment choices. With stocks, the cost of management is done only once, the initial outlay (Mishkin & Eakins, 2017).
According to Mishkin and Eakins (2017), mutual funds are considered attractive because of the provision of a financial manager, diversification, selection, and convenience. However, as per the views and research done by Atack (2010), today, more individuals living in the United States are opting to hold more stocks in firms as compared to purchasing mutual funds. This is because it seems more attractive and better to just pay a one-time brokerage fee to invest in stocks as compared to paying an annual fee of around 2% for professional management. However, getting professional experts manage your portfolio and ensure that junk stocks do drag the returns is not so bad. In fact, it is one of the main reasons why, according to Atack, in the modern times, people should consider mutual funds over stocks.
Mishkin and Eakins (2017) also note that mutual funds do not charge any percentage on short-term capital gains tax when the purchasing and selling is done within a year. However, an amount of almost 15% is charged on stock a factor that makes them less attractive. Furthermore, with the shares traded in the stock market, an individual has to pay a higher brokerage fee and also pay the demat charges. This is based on the fact that they do not negotiate the shares in larger scales like is the case in mutual funds. Investors in mutual funds share the brokerage fees and they hardly have to hold a demat account thus receiving an indirect benefit over stock investors (Howells, Bain, & Dawsonera, 2007).
To Bogle(2015), Mishkin and Eakins had a point in his argument about how beneficial mutual funds are compared to the stocks. This is because there is diversity that cannot be achieved while purchasing shares directly from the stock market. Bogle observes that a well-diversified portfolio has not less than 25 stocks and while an individual might try to create such a corpus, they might lack the expertise needed to manage it effectively and the funds. With mutual funds, such diversity is achieved instantly as an individual gets to buy various units of a mutual fund that is later invested across different stocks. Hence, an investor is able to receive the benefits associated with diversification without investing huge amounts of cash or maintaining a gigantic corpus (Howells, Bain, & Dawsonera, 2007).
Some of the features that make mutual funds attractive at times pull the returns down. This is according to Bogle(2015) who observes that diversification in mutual funds is beneficial at times but that same factor becomes the main aspect that holds returns down as it always tries to keep mutual funds from falling too far below the initial pricing. This makes individual stocks more attractive as they have an upside potential and an individual is able to trade some risks for better returns. Bogle also observes that a professional manager involved in mutual funds can make changes with regards to the stocks they invest in frequently as they please without involving the investors and this factor makes it hard for individual investors to track where their money is invested. In such a case, the benefits associated with a professional manager makes the mutual funds less attractive compared to stocks since an individual managing his own portfolio has the opportunity to know the firms and make the sole decision to invest in firms they choose (Mishkin & Eakins, 2017).
The revelations by various scholars make it harder for an individual to answer the question of whether to choose individual stocks or go for the mutual funds. This is why some for some investors, this question never arises and they opt to invest in both options. This is in order for them to be able to meet various financial objectives and have regular income even after retirement. This is according to Mishkin and Eakins (2017) who them states that while making an investment decision, the investor should always be keen and do adequate research before making any decisions. The reason is because different people have varied comfort zones and thus their decisions are different, unique and customized to their objectives and options. In any case, there is room for one to choose either individual stocks or mutual funds. Furthermore, an individual can still choose both options and still be able to achieve their financial goals despite retiring (Howells, Bain, & Dawsonera, 2007).
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Recommendations
For new investors, mutual funds and individual stocks in the stock market present the best options for investment plans. However, before making the final decision with regards to the option of choice, it is important for the investor to know exactly what each entails, how it is designed to function, investor expectations, and the risks involved when one makes the decision. By considering the time one has to spend on their chosen investment plan, they can opt for varied options and also considering the amount of risk that they are willing to take; their choice could also vary considerably (Mishkin & Eakins, 2017). In the previous subsection, it was clear that many consider the mutual fund investment plan as a passive investment option. This is because the investor is passively involved in the transactions, the risks and plans. The stock market and investing of money in individual stocks was on the other hand considered a more active form of investing but whether passive or active, both options carry their fair share of risks and advantages. Understanding these risks and benefits it the most important aspect of making the decision to invest in either or in both (Mishkin & Eakins, 2017).
Case in point, individuals making their first decision to invest money in either mutual funds or individual stocks can opt to research their options, and weight the risks and benefits involved based on the details that they find on the internet. They could also opt to hire experts to advise them according and help them understand what they are getting into, the risks, how it works, and even make the wise decision depending on their financial situation (Howells, Bain, & Dawsonera, 2007). Others could also consider both options and invest separately as they focus on spending the returns from varied options to meet their financial needs. In any case, while unsure, a person is expected to first ensure that they fully understand the time frames and limits for both options prior to making an investment (Mishkin & Eakins, 2017).
Individuals who are starting out in making their investment plans could opt for mutual funds since it best suits their needs. This is because the design of the plan is best suited for young people in their early years of employment who are not willing to take major risks, looking for diversity in their investments and with little knowledge and experience. Once a person has gained more experience, has worked for some years and saved a considerable amount of money, they could then think of individual stocks (Howells, Bain, & Dawsonera, 2007). At around 40 years old, an individual has gained experience and at that age, they can be able to create better strategies for their portfolios and they have more cash saved up from their years of employment to buy shares. These individuals also have more time on their hands to research and follow up on the performance of firms (Madura, 2009).
Conclusion
Depending on an individual’s financial plans, your time, experience, age, and understanding of the investment options, individual stocks and mutual funds can be suitable to them. Hence, an investor has to evaluate themselves, know the limit to which they can risk their money while making an investment and understand that, every person has deferent needs and a certain plan will suit them different compared to their friends or neighbors. So, should one choose mutual funds or stocks? The best answer is each has a different purpose and meant for different investors. By determining your group as an investor and learning the objectives you have offers one the best guide while deciding whether to go for mutual funds or individual stocks.
- Financial Markets and Institutions. (2005). Retrieved February 1, 2018, from https://spu.fem.uniag.sk/cvicenia/kf/cierna/Financial%20management/financial_markets.pdf
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- Bogle, J. (2015). Bogle on mutual funds : new perspectives for the intelligent investor. New Jersey: John Wiley & Sons.
- Groz, M. M. (2009). Forbes Guide to the Markets. New York: John Wiley & Sons, .
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