Mutual Funds vs. Self-Investing: Which Is the Right Approach for Average Investors?

Investing can be a daunting task for the average person, especially when deciding between managing investments independently or opting for professional help. Today, individual investors have two primary avenues to invest their money: self-investing through brokerage accounts or investing in mutual funds managed by professional portfolio managers. 

Although exchange-traded funds (ETFs) are gaining popularity, mutual funds remain a top choice for many investors due to their ease of use and professional management.

But what is the best choice for the average investor? Let’s explore the differences between self-investing and mutual fund investing, and weigh the pros and cons of each method.

Portfolio Management: DIY vs. Professional Help

Self-Investing

Self-investors take on the responsibility of managing their own portfolios. They must research, select, and buy individual securities such as stocks, bonds, and commodities. This route can be appealing to investors who want full control over their investments and have the time and expertise to track market trends.

However, the reality is that most average investors lack the necessary knowledge, experience, and discipline required to construct and maintain a well-diversified portfolio. Managing a portfolio involves constant monitoring and rebalancing, which can be time-consuming and requires a deep understanding of the markets.

Mutual Funds

In contrast, mutual funds offer a simpler approach. They are professionally managed by experienced teams of portfolio managers who are responsible for selecting securities based on the fund's stated objectives. This allows investors to leverage the expertise of professionals, saving them time and effort while still achieving diversified exposure to various asset classes.

For most investors, mutual funds provide an easier way to invest with less risk and fewer hassles compared to self-investing.

Diversification: Spreading Risk

The Importance of Diversification

Diversification is a fundamental principle of investing. Spreading investments across different asset classes—such as stocks, bonds, commodities, and real estate—reduces the impact of a poor-performing asset on your overall portfolio. By diversifying within each asset class, investors can achieve better risk-adjusted returns over time.

For self-investors, achieving proper diversification can be challenging. To properly diversify, a self-investor would need to buy at least 30 different securities, spread across various sectors and asset classes. For instance, this might involve purchasing 17 stocks, 7 bonds, 3 commodities, and 3 real estate stocks.

Mutual Funds: Instant Diversification

Mutual funds offer an easy solution for achieving instant diversification. A typical large-cap stock mutual fund, for example, might hold around 125 individual stocks. This diversification helps mitigate the risks associated with holding individual securities.

With mutual funds, investors only need to buy 2-3 stock funds, 2-3 bond funds, and a few funds that cover commodities or real estate. This approach ensures that their portfolio is well-diversified without having to buy dozens of individual securities.

Economies of Scale: The Benefit of Pooling Assets

Challenges for Self-Investors

For a self-investor with a smaller amount of capital—say $5,000—achieving proper diversification can be challenging. It’s difficult to purchase enough shares of each security to create a balanced portfolio. Self-investors may be forced to buy smaller quantities of expensive securities or focus on cheaper, riskier options, neither of which is ideal.

Mutual Funds: Bulk Buying Power

Mutual funds, on the other hand, pool the money from all investors to purchase securities in bulk. This allows fund managers to buy shares at a lower cost due to the economies of scale, which in turn reduces transaction costs. As a result, investors in mutual funds benefit from lower costs, even when investing relatively small amounts.

Cost of Investments: The Hidden Costs

Costs of Self-Investing

When self-investors add money to or withdraw money from their accounts, they must purchase or sell securities. Each transaction comes with a commission cost, and while there are no management fees for self-investors, they are still responsible for making the right decisions to avoid unnecessary costs.

Mutual Fund Management Fees

Mutual funds charge management fees, which typically range from 0.5% to 2% of assets annually. While this may seem like a significant cost, it’s important to consider the value of professional management, diversification, and the economies of scale provided by mutual funds.

Investors can buy into mutual funds at any time with no transaction fees, making it easier to manage investments without worrying about commissions. The annual management fees are a small price to pay for professional portfolio management and risk reduction.

Conclusion: Mutual Funds vs. Self-Investing

While self-investing may work for experienced investors who have the time and knowledge to actively manage their portfolios, mutual funds are generally a better choice for the average investor. The benefits of professional management, diversification, economies of scale, and lower costs make mutual funds a superior option for most people.

For those looking to simplify their investment approach and avoid the stress of managing individual securities, mutual funds offer a convenient and effective solution. Investing is challenging enough without the added complexity of managing a diverse portfolio on your own. By choosing mutual funds, investors can rest easy knowing their assets are being handled by experts with a focus on long-term growth and risk management.