Stocks and mutual funds offer many benefits to investors. When you buy a stock, you own a share of the company. You can make money when stockholders receive dividend payments and when you sell the stock. This provides a steady stream of taxable income for as long as you hold the stock. When you buy a mutual fund, you pool your money with other investors to buy stocks and other securities.
What is the difference between mutual funds and stocks?
Mutual funds achieve diversification in two ways. Depending on the type of mutual fund you are considering, it may contain a mix of stocks and bonds. Bonds are a safer investment than stocks, so mixing them in your portfolio helps reduce risk.
Even when a mutual fund contains 100% stocks, those stocks are not all in one company. If a single company faces a scandal leading to a stock collapse, the mutual fund investor will not be affected as much as an investor who only owns that company’s stock.
Mutual funds are less risky than individual stocks due to the diversification within the funds. Diversifying your assets is a key tactic for investors who want to reduce risk. However, the reduction of risk may limit the returns you ultimately receive from your investment.
Let’s take the example of Lehman Brothers. In 2008, when Lehman Brothers filed for bankruptcy, it was the fourth largest investment bank in the United States. Many mutual funds held shares of Lehman Brothers, and they experienced a drop when Lehman Brothers closed. However, individual investors who bought and held shares of the now-defunct company lost all the money they invested.
By considering your emotional risk tolerance and financial situation, you can determine the risk-to-return ratio that works best for you.
Potential Rewards: Mutual Funds vs. Stocks
The trade-off for taking less risk by choosing a mutual fund instead of stocks is that most mutual funds will not increase at the same rate as the top-performing stocks. For example, in the initial disclosures of Amazon’s securities to the Securities and Exchange Commission in 1997, it was estimated that the stocks would begin selling between $14 and $16. On April 8, 2020, Amazon’s shares opened at over $2,021. Individual investors who bought shares in the late 1990s could enjoy all the equity gains that come with this massive rise. However, the benefits of this rapid growth are muted for mutual fund holders.
Mutual funds do not necessarily have to contain stocks. Bond funds primarily invest in bonds or other types of debt securities that return a fixed income. They are relatively safe, but historically offer lower returns than stock funds.
Time: Mutual Funds vs. Stocks
Mutual funds are overseen by a fund manager, who controls when and what to buy or sell with the pooled money of all investors. The management can be active or passive. Funds managed by active management have a manager trying to outperform the market. Managers of funds managed passively simply select an index or benchmark, such as the S&P 500, and replicate it with the fund’s assets.
Investors still need to research mutual funds, but there is less work involved. You decide what type of mutual fund you need, whether it’s an index fund, a sector-specific fund, or a target-date fund that adjusts to the investor’s needs over time. You should also look at the historical performance of the mutual fund and compare it with similar funds that track the same index or benchmark. There is no need to worry about the stocks within the mutual fund or when they need to be sold. The mutual fund manager will research individual investments and make decisions regarding trades.
When
When considering stocks or mutual funds, decide how much time you want to spend researching and whether you have the patience to learn how to evaluate financial data. If you want to invest less time, choose a mutual fund.
Costs and Fees: Mutual Funds vs. Stocks
Mutual funds come with fees that vary from fund to fund. Some funds charge fees when you buy the fund, others charge fees when you sell the fund, and some do not charge fees if you hold it for a certain period of time. Many funds charge management fees to compensate fund managers. Some funds require a minimum investment, which can raise cost barriers.
Most actively managed funds buy and sell stocks throughout the year. If there are capital gains on those trades, you may have to pay taxes on them, even if you didn’t personally sell any shares of the mutual fund. Even if the overall value of the mutual fund decreases, you may incur capital gains taxes on the sales that the fund made.
You can reduce the tax impact by using tax-advantaged retirement accounts, such as a Roth IRA or 401(k). There are also tax benefits to choosing exchange-traded funds over mutual fund investment accounts.
If your main concern is avoiding additional costs and fees, investing in stocks is the optimal way. You will still pay taxes on capital gains, but otherwise, the only fees you will incur are those charged by your broker on trade orders. If you have a commission-free broker, you won’t pay those fees.
Conclusion
While everyone’s situation is different, there are some general rules you can use to guide your investment decisions. If you want to reduce risk and your research time, and you are willing to incur some additional costs and fees for that convenience, mutual funds may be a better investment option.
On the other hand, if you enjoy diving deep into financial research, are willing to take risks, and want to avoid fees, then investing in stocks may be the better choice. You should decide how much risk you can tolerate against the amount of money you wish to earn. If you want a higher return, you must accept higher risks.
Frequently Asked Questions (FAQs)
Are mutual funds risky?
There is a certain amount of risk in all types of investments, but the exact amount of risk in a mutual fund largely depends on the type of fund. An actively managed growth fund will have significantly more risk than a government bond fund, but the government bond fund will be among the lowest-risk investment products. Compared to individual stocks, a mutual fund that tracks a broad index is less risky.
How can I buy stocks or mutual funds?
Stocks and mutual funds can be purchased using most types of investment accounts, including brokerage accounts and retirement accounts. However, the purchase orders for stocks differ from those related to mutual funds. Stock orders can be executed as soon as the stocks are available at the price you wish to pay. If you do not mind the price, you can get the stocks immediately (in case the stock market is open). Mutual fund orders are executed once daily, regardless of when they are placed, so the stocks will not be added to your account quickly.
What age should investors be to invest in stocks or mutual funds?
Only adults can invest, meaning you must be at least 18 years old before you can invest on your own. Those who have not reached adulthood can invest with the help of a trusted adult through a custodial account. Custodial accounts are technically the property of the minor, but they do not have direct access to the account until they become adults.
Source:
https://www.thebalancemoney.com/should-you-invest-in-mutual-funds-or-stocks-3306145
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