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How To Invest – Stocks or Mutual Funds?

Oh the stock market! So exciting, so much fun, so profitable, so dangerous. It’s easy to get swept up in the excitement of the stock market… placing bets, pitting your mind against the world, and making money – hopefully making money – oh please let me make just a little money -hey what happened to my money?

Many new investors often wonder what the best way to invest in the stock market is. Should you invest in individual stocks, or should you invest in a good solid mutual fund or even an index fund? That’s exactly what I’m going to talk about in this article today.

Most new investors dive right in and start picking individual stocks using either a stockbroker or an online stockbroker account like E*TRADE or something like that. This may not be the best idea for everybody for two main reasons. The first one is that you may not know or have the training necessary to pick good stocks. The other reason is purely mathematical and I’ll explain that in a minute.

When it comes to individual stocks there are two things you have to consider. The stock market is all about risks and assessing different risks. For individual stocks there are two main risks. The first one is individual risk that comes from the particular company and their industry. Will their new product take off? Will a competitor come out with a better product? Will the CEO quit? Is there fraud? Will the company make its quarterly earnings estimates? These are the sort of things that are related to the stocks individual risk and they are what most investors focus on.

The second type of risk is the market risk. Like it or not, each and every stock is correlated to the stock market in varying degrees. What this means is your company may have had a record year which would make you think the stock was about to shoot up. Unfortunately you may be in a recession that is dragging down the entire market. That drag can drag down an individual stock such as the one you have invested it. This is what we refer to as market risk.

The problem most individual investors have is that they focus on mitigating individual risk and they ignore market risk and then they get side-struck by it. Fortunately there is a way to eliminate market risk and that is through diversification.

It is mathematically possible to completely eliminate market risk by diversifying broadly. The problem is, most individual investors can’t afford to purchase enough stock to satisfy the mathematical requirements. You may have to purchase 100 or 200 stocks to fully diversify away the market risk and that’s just not realistic for most individual investors. Heck the transaction costs alone will eat up most of your profit.

That is why most individual investors, especially those just starting out, choose to invest in a good solid mutual fund because those mutual funds do in fact diversify away most of the market risk. In fact, that’s one of the main reasons why people invest in them is because they are able to buy hundreds of different stocks where an individual investor couldn’t.

So there you have it; why you should invest in mutual funds and why you should stay away from individual stocks if at all possible.

Written By Jason Markum

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