A few years ago, John Grable couldn't find enough good things to say about mutual funds. A financial adviser near Reno, Nev., Mr. Grable would invariably recommend that his clients plow their money into funds.
Today, Grable instead recommends that investors buy individual shares of stock.
"I slowly came to the conclusion that there was no inherent price advantage" to mutual funds over individual stocks, he says. In fact, Grable, now pursuing a doctorate in personal finance in Virginia, says the strategy may offer both lower investment costs and useful tax breaks. And the small investor who does some homework may actually produce better returns than a mutual fund manager, he suggests. The majority of all mutual funds fail to equal or exceed market averages.
In recent years, mutual-fund companies have repeatedly raised commissions, management fees, and advertising expenses. A few brave mutual fund executives, including John Bogle of the Vanguard Group, have spoken out against this trend. But costs continue to climb.
Meanwhile, minimum entry levels have escalated, making it more difficult for small savers to buy into a fund in the first place. Few fund families now offer minimum entry amounts under $1,000. Just last week, for example, the Berger Group of funds in Denver raised its entry bar from $500 to $2,000.
"Mutual funds do provide management expertise and instant diversification," says Hans Stoll, a professor of finance specializing in the stock market at Vanderbilt University in Nashville. "But they may not provide any cost advantage" over a selected assortment of stocks.
"I'm surprised that the stock exchanges have not made more of this," Mr. Stoll adds. Still, he notes, some exchanges now offer inexpensive fund like products that are sold as individual stocks.
'Spiders' and 'Webs'
The American Stock Exchange, for example, has developed two successful products called Spiders and Webs. Spiders, (technically, SPDRs) are Standard & Poor's depositary receipts. They are miniature replicas of the S&P 500 stock index. Each share currently trades in the $70 range. Thus, using a discount broker, a person could pick up one share for about $100 or 10 shares for perhaps $735. By contrast, to buy into the Vanguard 500 index fund you would have to invest a minimum of $3,000 in a regular account or $1,000 in a retirement account.
Webs are world equity benchmark shares, which tend to focus on a single country or region. Share prices vary, depending on the index used, but are less costly than buying into most global equity funds. (To learn more about Spiders and Webs, call 1-800-THE-AMEX.)
There is one inexpensive type of fund, Stoll says: the index fund. Annual fees on the Vanguard 500 fund are 0.2 percent of assets invested. There is also a $10 annual fee if the investment is less than $10,000. That's much lower than a typical stock mutual fund, with fees of more than 1 percent annually.
Then there are the "loads," or sales charges, that many funds have.
Consider the example of investing $1,000 in the Pioneer Fund II. (As noted, most funds will no longer even let you in for that amount.) The load is 5.75 percent, or $57.50 on your $1,000 investment.
By contrast, if you had instead invested $1,000 using a discount broker, your commission on a purchase of 100 shares of Company X would be less than $57.
Internet trading cheaper
Some brokers charge as little as $15 to $20 for a trade placed over the Internet.
But what about investing the same $1,000 in a no-load mutual fund? Would you not come out ahead? Not necessarily, Stoll says. You would need to measure a number of factors over time, including annual management fees, advertising and promotion expenses, and taxes.
For example, once you acquire a share of individual stock there will be no capital-gains tax until you actually sell the stock. That could be decades away. The timing is up to you. With a mutual fund, the portfolio manager typically buys and sells stocks throughout the calendar year. That means that at the end of the year, you will incur a capital-gains tax on your portion of profit from those shares sold within the portfolio. In addition, you will incur the annual management expenses already discussed. This fee comes out of the price of the fund, reducing your investment gain.
In addition, "There is always some latitude for adjustments on commissions with brokers," says a stock broker in Princeton, N.J. Special discounts, for example, are available from some of the brokers listed in the accompanying chart.
For a person with $100,000 in no-load funds, annual expenses can run between $1,000 and $2,000 a year, Grable notes. By contrast, owning individual securities worth $100,000 would cost virtually nothing in management expenses, he says, except for small storage charges if held with a broker.
To reduce costs further, buy shares through a direct stock-purchase plan (offered by many publicly owned corporations) or a low-cost purchase plan offered by investor groups, such as the National Association of Investors Corp. in Madison Heights, Mich., reachable by phone at (810) 583-6242.
Grable notes that, to enter a direct-purchase plan, you often must first buy one or more shares of the company through a broker.