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As a new investor, it's helpful to consider your investment choices, including the choice of mutual funds or stocks. Confused? Many new investors are.
What is the Difference Between Mutual Funds and Stocks?
When you invest in individual stocks, you're buying shares (the stock) of a single company. When you invest in a mutual fund, you're buying shares in a fund which invests in multiple securities such as:
- Money market instruments
- Other assets
Each mutual fund usually has an investment objective that states how the fund will invest. This may be based around a number of things including:
- An industry (financial, real estate, technology, healthcare, etc.)
- A region (European, American, Asian or emerging markets)
- An index.
People have different reasons for buying mutual funds vs. stocks. Someone could do both as part of their investment strategy.
Pros & Cons of Mutual Funds
Investing in mutual funds work for those who want to participate in the stock market but don't necessarily want to pick and follow specific stocks. Owning "baskets" of stocks gives investors the advantages of being in the stock market and diversifying their investments1while saving them the trouble of picking their own stocks by letting financial pros do the picking or by using an automated index approach.
Pros of Mutual Funds
- Risk is spread out by investing in multiple companies as part of a diversified investment fund. It can be harder to do when picking individual stocks.
- If an individual stock loses value, other stocks in the mutual fund help to balance it out. You haven't put all your eggs in one basket, however, all the stocks in a fund could lose value at the same time.
- A financial professional chooses which stocks go into the fund and then manages it. You don't have to closely monitor individual stocks.
- If you're interested in a specific industry sector, you can invest it that sector without having to individually choose stocks.
Cons of Mutual Funds
- If a single stock excels, you miss out on some of that high growth. You'll benefit from that growth if the stock is included in your mutual fund, but not to the same extent, as the stock will be diluted by the others in the fund.
- Those who prefer greater control over their investments may not like giving away choice in stocks to a mutual fund's managers.
- Some funds have minimum investment rules and require the fund be held for a certain amount of time before cashing out or you could be charged a fee if you cash out early. Mutual funds also charge a percentage of the investment as a management fee.
Pros & Cons of Stocks
Buying stocks can be a good choice for people who want to own specific stocks and are able to handle more potential volatility.
Pros of Stocks
- You control what stocks you invest in.
- If a stock soars, you'll get all the benefit from that increase. If you had that stock in a mutual fund, the benefit would be diluted by the other stocks in the fund, but also have to bear all the loss if that stock falls in value.
- People might find it exciting and rewarding to pick and follow specific stocks.
Cons of Stocks
- Stocks can be volatile. The highs and lows are emotionally difficult for some investors.
- It can be time-consuming to monitor individual stocks. This is opposed to simply buying and holding a share in a mutual fund.
- You could be charged a brokerage fee every time you buy or sell an individual stock.
The Bottom Line
If you haven't previously been investing in mutual funds or buying your own stocks, or new to investing, you could try each approach to see which you like best, as long as you keep the potential risks in mind. There are risks involved in both types, including the potential to lose the entire principal amount invested. Those who are new to investing might find it easier to invest in mutual funds.
Whatever you choose, your investments decisions should always be based on your individual goals, time horizon and risk tolerance.
1 Diversification cannot guarantee a profit or protect against a loss in a declining market.