Mutual funds are investment vehicles that pool money from multiple investors to buy a diversified portfolio, while stocks represent ownership in a specific company and their value fluctuates based on the company's performance and market conditions.
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Key Takeaways
Mutual funds diversify investments, reducing risk, but also limit potential gains.
Mutual funds are managed by professionals, reducing the need for monitoring, but investors give up control.
Stocks offer higher returns but come with higher risk and volatility.
Both mutual funds and stocks have fees and expenses that can affect investment returns.
The choice between mutual funds and individual stocks depends on an investor's goals, time horizon, and risk tolerance. A diversified portfolio may offer a good balance.
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:
Stocks
Bonds
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 workfor 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 investmentswhile saving them the trouble of picking their own stocks by letting financial pros do the picking or by using an automated index approach.1
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 isopposed 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.
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Footnotes
Diversification cannot guarantee a profit or protect against a loss in a declining market.
Stocks are more appropriate for investors who can monitor their portfolios and the stock market for opportunities. Mutual funds are more suitable for investors who want a fund manager to do all of the work for them. Bernat summarizes what investors should consider before choosing the right approach for their portfolio.
A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.
While equities can offer the potential for higher returns, they come with higher risk and volatility. Mutual funds generally provide good returns over the long term, especially after 5 years, due to their diversified nature and professional management.
Last year, 47% of actively managed open-end mutual funds and exchange-traded funds beat their benchmarks — a marked increase over the 43% hurdle rate in 2022. Morningstar refers to the boost as a “surge.” Yet active managers haven't become better at beating the market over the long term, as Morningstar acknowledges.
Their value fluctuates based on the company's performance and overall market conditions. Ultimately, the choice between mutual funds vs stocks depends on your risk tolerance, investment goals, and level of comfort with the stock market.
The underlying securities of mutual funds comprise stocks from different companies. Due to this, mutual funds offer you the benefit of diversification. However, during a market crash, stock prices come down. This, in turn, pulls down the performance of mutual funds holding these stocks.
Mutual fund investments when used right can lead to good returns, keeping risk at a minimum, especially when compared with individual stocks or bonds. These are especially great for people who are not experts in stock market dynamics as these are run by experienced fund managers.
Markets will reward you for not exiting during a crash
Mutual funds are long-term investments. If you stay invested, you can take advantage of rupee-cost averaging. Markets have rewarded those who have not pulled out their investments during crashes.
The first step is to identify your financial goals and the time horizon for achieving them. Different mutual funds have different objectives, such as capital appreciation, income generation, tax saving, etc. You should choose a mutual fund that matches your goal and risk profile.
Investors can invest in high-risk funds for higher returns for their long-term goals. Investors with a low-risk appetite can invest in low-risk funds for their short-term goals.
If you own stocks through mutual funds or ETFs (exchange-traded funds), the company will pay the dividend to the fund, and it will then be passed on to you through a fund dividend. Because dividends are taxable, if you buy shares of a stock or a fund right before a dividend is paid, you may end up a little worse off.
However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.
For the top 20 funds, the average 10-year annualized return was 20.83%. For comparison, the S&P 500's annualized return for the same decade was about 12.39% . For the full list of the top 20 mutual funds of 2013 to 2023, scroll through the cardshow below. (All data is from Morningstar Direct, and is current as of Oct.
In the case of a Mutual Fund company shutting down, either the trustees of the fund have to approach SEBI for approval to close or SEBI by itself can direct a fund to shut. In such cases, all investors are returned their funds based on the last available net asset value, before winding up.
Potential for loss: Mutual funds are not FDIC insured and may lose principal and fluctuate in value.
Cost: A mutual fund may incur sales charges either up-front or on the back end that are passed on to the investors. In addition, some mutual funds can have high management fees.
All investments carry some risk, but mutual funds are typically considered a safer investment than purchasing individual stocks. Since they hold many company stocks within one investment, they offer more diversification than owning one or two individual stocks.
Experts say that once a certain minimum amount of money, which could vary from six month's income to three times one's annual salary, is collected, then one should begin investing in mutual funds.
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