Stocks and mutual funds are both popular forms of investment, allowing investors to build portfolios and grow their wealth. Although mutual funds often include stocks, mutual funds and stocks have different characteristics that may appeal to different investors with different objectives.
Here are the key features, as well as the pros and cons, of stocks versus mutual funds.
Stocks versus mutual funds
Stocks and mutual funds both offer ways to build a portfolio, but there are differences in how they work and what you can expect over the long term.
A share represents a share of ownership in a company. When a company like Tesla (TSLA) or Amazon (AMZN) does well, those who own shares receive the benefit. As the company grows, the stock price usually rises along with it, giving investors the opportunity to sell shares for more than they bought them for.
Meanwhile, a mutual fund is a pooled investment that contains shares of many different assets. Many mutual funds include a wide range of stocks and bonds, often hundreds. When you buy shares of a mutual fund, you receive a portion of everything that’s included.
In addition, there are index mutual funds that track popular indexes, such as the S&P 500, which can be purchased at a very low cost. Other funds may be actively managed, where a professional chooses what to include in the mutual fund based on different goals, such as growth or income. Actively managed funds incur higher costs and tend to underperform passive funds over longer periods of time.
You can buy shares and investment funds through your investment account. Employer-sponsored retirement plans, such as 401(k)s, typically invest in mutual funds, so you may already own these funds without realizing it.
The pros and cons of shares
Stocks offer a potentially valuable way to grow your wealth and benefit from big price movements, but they also come with some disadvantages.
Positives
- Easy to trade – Individual stocks are easy to trade through an online broker, and there are a number of apps that make the process intuitive.
- Potential for Big Gains — Depending on stock performance, you could see big gains. This could lead to greater prosperity in the long term.
- Low trading costs — In many cases, stocks come with low trading costs. In fact, many brokers do not charge trading fees for individual stocks.
Disadvantages
- Potential for Big Losses – While there is the potential for big gains, you could also suffer big losses if the stock price falls and doesn’t recover.
- Research takes time — Researching stocks and choosing the assets that best suit your portfolio can be time-consuming.
- Stress — Investing in stocks can feel like an emotional roller coaster. It’s important to understand your own risk tolerance before you start investing.
The pros and cons of investment funds
Mutual funds can provide some diversity in your portfolio, but they are not foolproof. Here’s what you need to know.
Plus points
- Can Have Low Expenses – Many mutual funds, especially passively managed index funds, can have low expenses, meaning they don’t charge a high expense ratio or fee. Additionally, some brokers offer their own funds without trading fees.
- Instant diversification — Because you invest in a basket of assets, you have instant diversification and therefore less risk, rather than having to buy multiple individual stocks to diversify your portfolio.
- Can be less stressful — In some cases, investing in mutual funds can be less stressful than investing in stocks. Because you own a diversified portfolio of stocks, the fund is likely to be less volatile than if you owned only a handful of stocks.
Disadvantages
- Some funds have sales charges. There are mutual funds that charge a fee when you buy or sell shares. These sales charges can cost you money before you even start investing.
- Can have high fees – Some funds charge a high expense ratio, sometimes more than 1 percent of your investment in the fund per year, but there are cheaper funds available.
- May not be tax efficient: If the mutual fund has sold assets and made a profit, you may see distributions that produce a taxable gain. So even if you haven’t sold your mutual fund shares, you may still be subject to capital gains taxes.
- May underperform the market. If you have an actively managed mutual fund, or one managed by a team of traders, it may not perform as well as the market and you could even lose money. Expense ratios also tend to be higher for actively managed mutual funds.
Stocks vs. Mutual Funds: Which is a Better Investment?
Whether stocks or mutual funds are better for your portfolio depends on your personal goals and risk tolerance.
For many investors, it may make sense to use investment funds for a long-term retirement portfolio, where diversification and less risk are important. For those looking to capture value and potential growth, individual stocks offer a way to increase returns as long as they can emotionally handle the ups and downs.
For beginners who have a small amount to invest: Starting with index mutual funds and making regular contributions can be an effective way to build a portfolio. Later, after you gain more experience, consider expanding into individual stocks. Think carefully about your goals and use investments to create a strategy designed to help you get there.
If investing in the stock market is too risky for you, consider these low-risk investments for your portfolio.
In short
Stocks represent shares in individual companies, while mutual funds can include hundreds – or even thousands – of stocks, bonds or other assets. However, you don’t have to choose one or the other. Mutual funds and stocks can both be used in a portfolio to help you grow your wealth and achieve your financial goals. Consider carefully how each of these options suits your needs and personal investing style.
You can also consider investing in exchange-traded funds (ETFs). When you compare mutual funds to ETFs, you will notice many similarities, but there are also differences. Make sure you do your research before investing.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
