In general, I am a big fan of buying shares of companies you know something about.

When mutual funds got their second wind in the late 1980s, they democratized American investing. Just 6% of U.S. households owned funds in 1980. The figure was 48% by 2005.

The typical stock mutual fund is a portfolio of about 100 companies, managed by a professional and backed by a research staff. Broad diversification reduces risk, providing what Harvard economist John Campbell calls a free lunch. And the cost for the stock picking and record keeping is pretty reasonable — on average, about $1.25 for every $100 invested annually. For nearly all investors, mutual funds make good sense. But many financial planners go too far when they admonish clients to own mutual funds exclusively. There are excellent reasons to own plain old individual stocks as well.

Serious money. Mutual funds have two big drawbacks. First, the fund manager makes decisions, such as taking copious capital gains, that can have a major effect on your tax bill. Second, mutual fund fees mount steeply over time. Take Fidelity Contrafund, which has relatively low annual expenses (0.92%) and no sales fee. If you invested $10,000 in the fund, and it returns an average of 10% annually, at the end of ten years you’d have paid $1,453 in expenses — or nearly 15% of your original cost. It’s not hard to find stock commissions of $50 or less for a round trip.

But a more important reason to invest in stocks is that you have a chance to make some serious money doing it. No doubt diversification diminishes risk, but it also reduces profits. Over a long period of time, investing in a broad-based mutual fund will produce returns that are roughly the same as the stock market as a whole. If history is a guide, those returns won’t be chicken feed — about 9% annually after expenses — but they’re unlikely to be a feast.

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Consider a hot sector: energy. Over the three years that ended March 1, Vanguard Energy fund returned 178%. Nice. But many individual energy stocks have run circles around Vanguard Energy and all the other energy-sector funds. For example, Southwestern Energy (symbol SWN ) returned 997%, and it is by no means the top- performing energy stock.

The way to make money in the stock market is to make relatively large investments in a relatively small number of stocks. This approach is the opposite of what most people are taught, but some of the best financial minds believe in concentration. Warren Buffett is fond of quoting bawdy Mae West: Too much of a good thing can be wonderful. His philosophy in running Berkshire Hathaway (BRK/A ) is simply to buy good companies at good prices, not to maintain a balanced or widely varied portfolio. Diversification, says Buffett, is a protection against ignorance. It makes very little sense for those who know what they are doing.

John Maynard Keynes, the most influential economist of the 20th century and a highly successful investor in his own right, wrote, As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.