Can I diversify with a few stocks or do I need a mutual fund?

Q. I would like to know if it’s better to own diverse stocks (for instance, one bank stock, one energy stock, one railway stock, one telecom, etc.) or mutual funds which are no-load and low MER such as the Mawer group of funds? Which method would be better for someone like myself who has a 15-to-20-year time horizon? How would I determine the best time to start cashing out? Is there a formula or book I can refer to?

Thanks! – Minnie

A. Minnie, this may be a case where a mutual fund, with its slightly higher costs, is the better choice than a stock portfolio. Why? It has to do with the difference between speculating and investing.

My definition of investing is the willingness to accept the average return of all of the stocks listed on a particular stock exchange. You can capture this return by investing in an index-type mutual fund or something similar. As long as you’re investing in businesses located in countries that allow the owners to keep their profits, then there is no reason why you shouldn’t be able to share in that profit if you invest with them.

Related Smooth out your performance

Some companies will fail, new companies will start up, and most businesses will find a way around future setbacks and continue making profits.

When you own most of the stocks in the market through a low-fee mutual fund like Mawer you’re so well diversified that you’ll be exposed to less risk from the companies that fail.

Still, some people argue that too much diversification mutes investment returns, and they like to speculate with stocks.To me, speculating is when you take a position on a stock (business) or sector (banking, energy, etc). Those stocks are going to go up or down because of a multitude of reasons—economic news, company annual report findings, statements from CEOs, government policies, news reports, and so on. Why speculate? The only reason to speculate is because you believe you’ll get a better return selectively picking stocks, than if you just bought the market index. But historical data shows that when you try to beat the index you are taking on more risk.

Related: Rethinking diversification

Having said that, there are people that successfully pick their own stocks and do well. You may be—or hope to become—one of those people. If it is something you are interested in I don’t want to deter you from trying some of your own stock picking and learning about investing along the way. Even if you try and later realize it’s not for you, you’ll become a better investor. My only caution is to be sure to start small with only a few thousand dollars. It’s not easy to recover from mistakes.

You asked for a reference to a formula or a book. Here is a book, without much fluff. Author Grant Ross gives you a simple formula to follow and he explains how to track things. Grant is the e-book author of Destination: Early Financial Independence, available on Amazon and Kobo for $5.99.

Allan Norman, M.Sc., CFP, CIM, Atlantis Financial/IPC Investment Corp.

MORE ABOUT ASK AN INVESTMENT EXPERT:

• Why Jane shouldn’t cash out on stock crash fears
• Why diversify? This chart shows you why
• What’s the right retirement asset mix if you have a DB pension?
• Should Eleanor invest her $20,000 in a TFSA or RRSP?
• How to transfer from an RRSP to a TFSA —and why you shouldn’t