How Should You Invest?

You’re familiar with stocks and mutual funds, and you want to invest some money to build a war chest for retirement. Should you park your hard-earned dollars in stocks or in funds?

Mutual funds, featuring the pooled and professionally managed money of many investors, are appealing — but they come with fees. They also aren’t likely to perform as well as the best individual stocks. Netflix stock, for example, has averaged annual growth of more than 36% over the past 15 years. That’s hard for any fund — and most stocks — to beat.

But investing in individual stocks requires you to have the time, interest and skill to study companies, looking for the ones that are healthy and growing at a good clip, yet are undervalued. You’ll need to know the difference between net and gross profit margins, and be able to calculate or understand various metrics such as return on equity, return on assets and return on invested income. Ideally, you’ll enjoy poring through balance sheets and income statements.

Once you identify and buy into some promising companies, you’ll need to take the time to follow them, reading their quarterly and annual reports, and keeping up with their development. You want to know, for example, if their market share has been falling or if a scandal threatens to derail their progress. Also, after buying into a stock, you’ll need to have a good sense of when to sell.

If all this doesn’t sound like you, you’re probably better off sticking with mutual funds — index funds, in particular. The stock market has returned an average of close to 10% annually over long periods, and relatively few mutual funds top that. But you can roughly match the market average with a low-fee, broad-market index fund. Index funds tend to beat most managed funds, and they serve most investors well.

You might even invest in both index funds and some carefully selected individual stocks. With all funds, seek low fees and avoid sales loads. Learn more at Fool.com and Morningstar.com.