Small investors: Stock up on mutual funds

Q. Dear Rick: I’ve heard you say many times that unless someone has at least $500,000 to invest, they shouldn’t invest in individual stocks. If that’s the case, how can small investors like myself take advantage of investing in the stock market? — Tom, Canton.

A. Tom: That is something I believe in, though I think you’re misunderstanding the meaning of it. Although it’s true I don’t think small investors — most investors — should purchase individual stocks, that doesn’t mean you can’t take advantage of the stock market.

The reason I urge small investors not to buy individual stocks is because unless you have at least $500,000 to invest, it’s extremely difficult to buy a big enough variety of individual stocks to give your portfolio the all-important level of diversification it needs.

Another issue is very few investors have the time, insight and research tools required to decide which individual stocks to buy and when to sell them.

That being said, that doesn’t mean small investors should avoid the stock market.

In fact, I urge all investors to be relatively heavily invested in the stock market by investing in a well-diversified portfolio of stock-based mutual funds. That way they can own a percentage of a broad range of well-diversified stocks and they get the added benefit of highly skilled mutual fund managers who have the time and expertise to make wise investment decisions.

The only research and insight required, if you go this route, is to find and invest in between five and 10 well-diversified mutual funds that have at least five consecutive years of annual net percentage returns that meet or exceed those of their peers. Then, when one of those funds underperforms its peers for 18 months to 2 years, you can switch out to another one. Even the smallest and least experienced investor has the time to do that.

If you’d like your financial question answered, please send it to AskRick@BostonHerald.com.