Purchasing The Individual Stock Investment Finance Essay - Free Essay Example

Nowadays, everyone will start investment rather than saving. According to Dan Weil (2011), almost all financial advisers will recommend people have at least some of their money to invest in stock market. For investors who are following that advice, the major question for them was whether investing in mutual funds makes more sense than purchasing in individual stock investment. There is no simple answer for this question. It was depend on the investor; investor can either choose low, medium, or high risk, capital, and return to invest. Also, investor can invest in both mutual funds and individual stocks investment. According to Alexis Tech (2012), mutual funds investments have given great returns to investors over the years and so have stock investments. However, if those investors have not enough knowledge of stock market, then mutual funds might be the right choice for them. Besides, those investors who are interested in the market, but do not have time to manage t heir investment portfolio themselves should also went to mutual funds. Besides, a mutual fund is an investment vehicle that accepts money from various investors and creates a large pool (Michelle Smith, 2011). Mutual fund is a group investment, it gather money from several investor then only invested in the stock market by fund manager. Furthermore, there are different types of mutual funds, which is high risk high return, medium risk medium return and low risk low return for defensive investors. The investors can decide to choose a fund as per their needs, financial strength and risk taking capability. After that, investors only check for the funds when free, not daily basis and yet get returns on selected period. On the other hand, individual stock investment is for those who are professional in stock market. These kinds of person have technical knowledge of stocks, their charts and can predict the future stock price based on the intensive stock research. Public was named them stock market trader. Therefore, for those who lack of knowledge or experience of stock market, stock investment can cause a huge capital loss. Also, the types of stock investment was similar with mutual funds, it has high risk high return, medium risk medium return and low risk low return for defensive investors. Investors will decide to choose based on their need or expectation. The only different between stock investors and mutual fund investors was stock investors need to keep a track of the market on daily basis, because the investors are manage the stock by their own. In additional, the investor should educate himself about the way of the mutual fund industry functioning before investing in mutual funds (Alexis Tech, 2012). Investors should do research and find out which mutual fund companies have given consistent returns to investors over a period of time, check the performance of the mutual funds in the times of crisis such as economic recession as well. Otherw ise, individual stock investments can give more monetary benefits than mutual funds if done in an organized manner. On the other hand, factors that affects investors choosing mutual fund rather than individual stock investment was risk management, return, time, and capital. According to Joe Light (2011), risk management was one of the main concerns by investor during making decision. The main objective for an investor is to maximize the return and minimize risk. Also, asset allocation and risk management are widely recognized as being the keys successful investing, whether via mutual funds or individual stocks investment. Keeping the investment risk low is the best way to limit losses and maximize returns (Chuck Epstein, 2011). Mutual funds can lower the investors risk through professional managing group or funds manager. According to Certified Financial Planner (CFP), mutual funds are managed and supervised by investment professionals. As per the stated objectives set fort h in the prospectus, along with prevailing market conditions and other factors, the mutual fund manager will decide when to buy or sell securities. This will eliminate the investor of difficult task of trying to time the market. Compare to individual stock investment, Lindsey Gardner (2008) has shown that the risk of stock investment was higher than mutual funds. The value of the stock was highly depended on the financial capability of the shares issued company. Once the company went into bankrupt, the share price will fall sharply; the shareholders will lose their money. Also, the general status of country economic wills determines how a company fares in the stock market. In other word, the stock price will go down during the recession period of economic. Therefore, the risk of individual stock investment was higher than mutual funds based on the literature review. Furthermore, Austin Pryor (2008) has shown that mutual funds could reduce risk through diversification. Diver sification involves the mixing of investments within a portfolio and is used to manage risk. For example, choosing to buy stocks in the retail sector and offsetting them with stocks in the industrial sector, the investors can reduce the impact of the performance of any one security on their entire portfolio. In order to achieve diversified portfolio, investor may invest widely such as invest in stock and bond or securities at the same time. Mutual funds typically hold from 50 to 500 stocks in their portfolio. Therefore, any loss caused by the unexpected collapse of any one stock will have only a relatively minor effect on the pool as a whole. On the other hand, according to Dan Weil (2011), if an investor wants to achieve diversification through individual stocks, the investor at least has to invest 20 different stocks. Also, the risk will increase through invest in many stocks; because the investor has to manage 20 different risks from different stocks, it was not the objecti ve for diversification. Based on their survey, mutual fund was safety than individual stock investment through diversification. The second factor was return. Investment return was means the profit gain from the investment. The first concern of an investor was the return from investment, so return will be the factor to affect investor decision making. When investors decide to make an investment, they will evaluate the expected return from those investments before investing, and then only evaluate other factor such as level of risk. The return from mutual funds was not as high as individual stock investment, because mutual funds mostly invest in medium risk or low risk stock market. It has very low percentage to invest in high risk stock market (Alexis Tech, 2012). A good mutual fund can gain returns in the range of 15 to 25 percent on a yearly basis to investors. Compare to individual stock investment, Disqus (2012) has shown that individual stock investment has potential for delivering very large gains. Annual return-on-investment (ROI) of over 100% has occurred on a somewhat regular basis. According to Maggie OHoulihan (2012), common stocks have no limit for return, because the stock may growth for long time, which is means that the investor can gain for no limit. The following factor was time. In finance, time was divided into three types, which is short-term, medium-term, and long-term. Short-term was referring to any investment or financial plan within one year. Medium-term or call intermediate-term is referring to a plan with a term longer than short-term but shorter than long-term. The exact length varies according to the usage; it could be few weeks of few years. Long term was referring to a plan with a term of longer than one year. The exact number of year varies according to the usage. Time is very important for investors because time will help investors in their investment planning, such as choosing suitable investment product, m onitoring the performance and the most importantly was monitoring the risk. One of the advantages of mutual fund was time flexible. Time flexible was means the investor can choose the time for investment period. As this report mention before, time for investor was very important, some of the investors like to invest in short-term, some like medium-term and long-term as well. Mutual funds investors can choose any period based on their need. Besides, the mutual fund investor can reduce the time to monitoring the status of the fund due to the professional management. However, individual stock investor has to spend time to monitoring the performance of stock, therefore stock investment was consume more time than mutual funds. The final factor was capital. Capital was another main concern of investor. The meaning of capital is means the money of investor spends for investment. Investor will choose those investment product bases on their capital, because capital is the money they willing to spend for investment. According to Bryan Lorin Sudweeks (2011), mutual funds will minimal transaction costs. Mutual funds offer the advantage of economic scale in purchase or sale, because the transaction of mutual funds was large. Economic scale refers to the fact that mutual funds cost may decrease as the assets size of mutual funds increased. Brokers may lower the fees try to get more of the mutual funds business. Furthermore, mutual fund can eliminate the cost of an investor would incur when doing research of securities. The cost of managing numerous securities is dispersed among all the investors according to the amount of shares they own. In other word, the fund managers have more money to research more securities. Transaction cost is a cost incurred in making an economic exchange. For example, when people purchasing or selling a stock, must pay a commission to the stock broker, that commission is a transaction cost of doing stock deal. In order word, tran saction cost was a part of the investment fees. Based on this point, the researcher realize that mutual fund will reduce the investment fees, which means the investor can spend more to invest and pay lesser fee. Besides, investors can sell their shares and collect money from open-ended funds, which is a fund that can create and redeem shares on demand usually within two business days. If the open-ended fund was no-load funds, investors are not require to pay transaction costs when they buy or redeem shares (Bryan Lorin Sudweeks, 2011). Also, according to Austin Pryor (2008), mutual fund shares can be purchased in such small amounts, so its easy to get started. Investing in mutual funds usually does not require a large sum of money, because mutual funds is not like stock market, it is like a pool and investors put money inside the pool then only invested by professional. Most fund organizations do have minimum amounts needed to open an account, but minimums are often dramati cally lower for Individual retirement account (IRAs) and for automatic deposit accounts where an account those investors agree to make regular monthly deposits to build their account. However, according to DF (2010), stock investment has attached with brokerage commission fee. Every transaction of stock investment order executed costs some money. It makes the purchasing or selling the stock become prohibitively expensive and even reduces the profit from investment. Based on the research, the capital involved in stock investment was higher than mutual funds, which is means the cost for individual stock investment was more expensive than mutual fund investment. On the other hand, there are some models or theories will be used in this study. The first was Modern Portfolio Theory (MPT). MPT was developed by Edwin J Elton and Martin J Gruber at 1995, and they are from New York University. MPT was a theory of finance which attempts to maximize portfolio expected return for a give n amount of portfolio risk, or minimize the risk for a given level of expected return by choosing the proportion of various assets. MPT was a mathematical formulation of the concept of diversification in investing, which means MPT was selecting a collection of investment assets that had collectively lower risk than individual investment. According to Edwin J Elton and Martin J Gruber (1995), MPT models an assets return as a normally distributed function, defines risk as the standard deviation of return, and models a portfolio as a weighted combination of assets. The fundamental concept of MPT was the assets in an investment portfolio should not be selected individually, each of their own merits. For given amount of risk, MPT describe how to select a portfolio with highest possible expected return. Or given the amount of return, MPT describe how to select a portfolio with lowest possible risk. Therefore, MPT was a form of diversification, and explain how to find the best pos sible diversification strategy. The optimal portfolio concept was under Modern Portfolio Theory. It was used in 1952 by Harry Markowitz, and it shown us that are possible for different portfolio to have varying levels of risk and return. According to Harry Markowitz (1952), the theory was assume that the investors try to minimize risk when acquire higher return possible. It states that investor will act rationally, always making decision aimed at maximizing their return for their acceptable level of risk. Besides, optimal portfolio concept was to remind the investor must decide how much risk they can handle and then allocate their portfolio according to it. Furthermore, the study were applied risk and return tradeoff concept. Risk and return tradeoff is the balance between the desire for the lowest possible risk and the higher possible return. A common misconception is that high risk equal to high return. The risk and return tradeoff concept has shown that the higher risk has provide the possibility of higher returns, no guarantees. Just as risk means higher potential returns, it also means for higher losses. Finally, the previous research has provided evidence and the result that meet the objective of the study. However, there are some weakness exist in the previous research. Therefore, the researcher will continue the study to solve the weakness that appears in the previous research.