Being a lazy investor who likes periodic investments, mutual funds is the most obvious alternative for me. But, there are many people who favor investing in individual stocks that lead to dividend income. If the dividend income is the same in both cases, then which one to pick? I.e. what are the tradeoffs in each method? Here are some thoughts with an example.
Let us consider VDIGX as the example mutual fund and a dividend producing individual stocks basket. The stocks we will assume to be part of both VDIGX and the stocks basket are:
- Wal-Mart Stores, Inc.
- Johnson & Johnson
- Microsoft Corporation
- Merck & Company, Inc.
- TJX Companies, Inc.
- Chevron Corporation
For an investor to maintain an individual stocks basket of the above stocks, he/she has to do a financial analysis of the companies involved OR at the least, spent time studying the reports available in the internet, company’s SEC filings, etc. One also has to evaluate the price of the stock based on its earnings potential. In short, there is a reasonable amount of financial knowledge and capability needed to invest in individual stocks.And, tax time can be a pain 🙂
But, the advantages are that once you own the stocks, you (the investor) gets to decide when to sell the stocks, when to realize capital gains (short or long term), buy and hold forever OR sell at the opportune time, buy and sell instantaneously during the day, etc etc. There may OR may not be commissions involved for buying/selling depending on the stock broker platform used (etrade, vanguard, and a whole host of providers with different fees per trade).
VDIGX, on the other hand, is totally controlled by the fund manager who currently happens to be Don Kilbride, a recognized name in the industry. He decides when to sell or buy company stocks, in what quantity, which companies to buy, etc. So, there is a loss of personal control over the investment. In addition, you (the investor) has to pay Don a fee for managing the investments. Since I do not have the time nor the knowledge to do a financial analysis, I have to pay Don the fees to do the work on my behalf. Since Don has a proven track record of producing reasonable gain, I am betting that past performance is a reasonable (but not guaranteed) predictor of future performance. Due to the loss of control, you (the investor) cannot control the time of selling/buying stocks, realization of capital gains (short or long term), which companies to buy, etc. For example, Don OR some other fund investor could sell VDIGX shares and force a capital gain of the short term. In addition, if you do not invest in the fund anymore after a certain amount of money, you still have to pay Don some money.
The advantage of course, is that you (the investor) does not have to evaluate the financial stability of the company, the value of the stock, etc etc. Don has years of experience in picking such stocks and also has a well known company like Wellington/Vanguard overseeing the process of picking such stocks. And tax time is as easy as taking the 1099 form that Vanguard will send for VDIGX and filling up the form in a tax form 🙂
For the lazy investor (like me), VDIGX is perfect. For the more knowledgeable investor, picking individual stocks may be the way. Hope this article gives a flavor of the issues to be aware of in choosing mutual funds vs individual stocks.
PS: For a more detailed article on tax treatment, please read another post by HumbleFI titled Tax consequences of investing in Mutual Funds