Mutual funds and stocks are two of the most common ways to invest in the stock market.
It is a common misconception that mutual funds are always better for investors than buying stocks directly. While mutual funds offer more diversification and more professionally managed portfolios, stocks give investors more control over their investments.
The question is, which one is better to invest in? Keep reading to find out which is best for your investment strategy.
What is a Stock?
It is important that you understand what a stock or share is and the advantages and disadvantages of investing in stocks. The first thing to understand about shares or stocks is that they are nothing more than ownership in a company. Having stock funds is one method of getting into stock trading, actively engaging in the stock exchange market.
The share price will usually go up or down, depending on how well the company is invested in. Different types of shares are available, including common and preferred, with each type offering different benefits for investors.
A common stock gives the holder voting rights and potential dividend payments if the company has sufficient profits. A preferred stockholder would not have voting rights but could receive dividends.
An investor would purchase a preferred stock instead of a common if they were more concerned with receiving dividends than having a say in its management.
Investors can head on over to Nasdaq listings to see the top-performing stocks. For example, Facebook’s shares are considered one of the best (and most costly) to hold.
Advantages
Most people look at the stock market and think it’s rather risky and that investing in stocks is not a good way to build wealth. However, investing in stocks can be a profitable way to build wealth.
The main advantage of investing in stocks is that it provides a good return on investment. Stocks are liquid assets that can be sold at any time. Unlike other investments such as real estate or businesses, there are no restrictions or limitations on selling stocks.
It’s also a fairly straightforward process. You can invest online easily, and companies provide different services to make it easy for you to invest in the stock market.
You can also get professional advice on investing in stock markets and when to buy/sell stocks. Stocks also tend to be more tax-efficient in the long run as you can control when you buy and sell each one, leading to greater control over the capital gains taxes you pay.
Investing in the stock market is one of the best ways to make long-term profits which is why many people invest their money in stocks and earn a fair amount of profit from them.
Disadvantages
Before you invest in stocks, there are some risks and disadvantages that you should be aware of. You might not be able to get back your original investment.
The stock market is risky, and you don’t always get back what you put into it. If the stock price goes down, you lose money. But, of course, if the stock price goes up, you make money. But sometimes, after a company has had a “bad” year, its stock price stays low for years and never recovers.
Hence, it does not guarantee any specific rate of return. If invested poorly, stocks can result in lower net worth for the investor, especially if the market is down when he or she decides to sell.
You can also lose all your investment by picking the wrong stocks. You need to know a lot about investing to pick good stocks – certainly more than most people do.
You may not want to rely on others’ advice too much when choosing stocks; even experts can be wrong about which ones are good investments due to sudden and unexpected fluctuations in the market, which they cannot control.
What is a mutual fund?
Mutual funds are like mini-stock portfolios, so many people can afford to purchase a few shares of several different mutual funds rather than having to purchase one share of one company’s stock.
The basic idea is simple: a group of people contributes money to an investment company, and the company pools the money together to buy stocks, bonds, and other investments on behalf of the investors.
Mutual funds allow investors to diversify their portfolios, thus reducing risk.
Examples of successful and top mutual funds include Vanguard and Fidelity Investments.
Advantages
The main advantage of mutual funds is that they are relatively cheap and easy to use, a lot cheaper than buying stocks outright, and easier than trying to buy individual stocks in your portfolio.
There is no need for security and other services to keep the stock safe. Additionally, mutual fund managers can buy more stocks than ordinary investors because they have access to larger investment pools.
As such, mutual funds offer the ability to own several stocks at once with just one transaction. This allows you to add new money to your portfolio without multiple transactions.
Mutual funds tend to be less volatile than individual stocks, so you can sleep easier at night knowing that you won’t wake up tomorrow and lose half of your money overnight.
Mutual funds also provide liquidity for investors. This means that if an investor needs his money back before the specific date, he can get out at any time without penalty. If an investor puts his money into a stock, he can only sell it when it reaches a financial institution or is bought by another party.
Disadvantages
Investors in mutual funds do not own shares in the companies they invest in. Instead, they own shares in the fund itself. The fund itself is not a legal entity; it is a pool of investments done in the name of its shareholders who have partial ownership over those investments.
This means that if an investor wishes to sell shares, he cannot do so directly. Instead, the investor must sell them back to the fund, incurring a loss due to commissions charged by the fund and any difference between the price paid for investing and the price received for selling his shares.
Investors also do not get voting rights on corporations that they invest in through mutual funds. As with other investments, investors can still be affected by corporate actions such as mergers and acquisitions even though they do not hold stock directly in those corporations.
Also, they can be expensive since they charge management fees and other expenses. If you want to invest in a mutual fund, it’s important to compare the fees charged by one fund versus another before choosing one.
How are stocks and mutual funds similar?
Mutual funds and stocks have very limited similarities.
They both provide you with the opportunity to make money–either through dividends or growth. And they both can be affected in dramatic ways by the economy’s health.
As far as making money, it doesn’t matter which one you choose: they both give you access to stocks and pay out dividends. But that’s really where the similarities end.
How are stocks and mutual funds different?
Differences in management
The primary difference between mutual funds and stocks is that a portfolio manager professionally manages mutual funds, selecting which stocks to buy and sell based on the fund’s objectives.
Cost efficiency
Mutual funds can also lower transaction costs and provide greater liquidity than stocks. With mutual funds, you can access the investment benefits of over 50 stocks in one basket. All of the costs are bunched together under the expense ratio, with special consideration given to redemption fees and sales loads at the time of selling your shares.
On the other hand, stocks are bought and sold directly on the open market through brokers and dealers, with investors paying brokerage fees every time they trade. Investors have to operate a brokerage account and deal with more transaction fees for every single purchase and selling of shares.
Trading formats differ
Mutual funds are investment pools that come in two varieties: open-ended and closed-end funds.
A closed-end fund has a fixed number of shares. An open-ended fund operates like an exchange-traded fund (ETF) and is similar to a stock in that it has no fixed number of shares.
However, unlike stocks, mutual funds do not trade freely in the market; rather, their shares can only be bought or sold at the end of each trading day at whatever the current net asset value (NAV) is.
Risk exposure
Stocks also come with higher risk than mutual funds. While mutual funds may fluctuate in value due to changes in their underlying securities, their share prices will only fall as far as $0. But no stock is free from risk entirely; a company could go bankrupt, or its business could fail to perform well over time.
In addition, the stock market itself is volatile; in 2001, it suffered its largest one-year loss since the Great Depression of 1929.
Investment goals
Individual investors in stocks and shares are often more focused on taking advantage of the stock market’s volatility to beat it. Meanwhile, mutual funds operate on a similar concept to index funds regarding their investment style. They might not focus on beating the market index, only matching it or making the best returns through conservative investment objectives.
Mutual fund investors also have to consider factors like the fund’s past performance, the asset classes, and asset allocation in the fund’s portfolio and compare it to other funds using the prospectus, which details its fees and expense ratios.
The investment portfolio in mutual fund shares is thus more of a diversified portfolio and beginner-friendly approach than an experienced investor in the stock market.
Investing in Stocks vs. Mutual Funds: What’s right for you
There are many investors in the market; some benefit from its instability, while others lose. Therefore, it is important to be aware of your type of investor and where to put your money to ensure that you do not lose.
When you should consider stocks
Stocks can be a risky investment. When purchasing stocks, they are most prone to risk in times of market instability. These periods could last only a few days, or they could last years. During these times, stock prices can decrease substantially or even cut in half.
Investors keen on stocks should have higher knowledge of the market and its sentiment. They need to know how long they are willing to hold onto their stocks before selling them.
It’s also important that investors know when the markets will be unstable so they can plan accordingly by purchasing stocks sooner rather than later to avoid large losses.
Suppose an investor has a long-term investment horizon, meaning they will hold onto their stocks for at least five years. In that case, it might be worth purchasing stocks during market instability because there will be more time for the stocks’ value to recover and increase substantially.
If you are young and just starting, or if you’re willing to take on risk, investing in stocks may be ideal for you. Although there are risks involved with investing in stocks and many more possibilities for setbacks than mutual funds, the potential for higher returns makes it worth it.
When you should consider a mutual fund
Mutual funds are a great option for investors with limited time, lower risk tolerance, and/or investment experience or those who want to get professional management with minimum fuss experience.
The advantage of investing in mutual funds is that they are much easier to manage than individual stocks. If you do not have a great deal of time to carefully analyze your investments or want a low-risk investment option, then mutual funds might be best for you.
Mutual funds are typically less risky than stocks because the investor doesn’t have all his money tied up in one company. The fund managers have more experience and expertise with investing, which reduces the risk of losing money invested.
If you plan to take advantage of short-term price fluctuations in the stock market, you should consider investing in mutual funds.
FAQs
What is the difference between mutual funds and stocks?
Stocks refer to individual unit investments in a single company, whereas mutual fund investments include a basket of investments that benefit from diversification.
Are mutual funds more profitable than stocks?
The profitability of the investment depends on your overall investment goals and your risk exposure. For example, if you’re a conservative investor, mutual funds might give you safer and better returns.
Are mutual funds safer than stocks?
Mutual funds can reduce risk and provide exposure through investing in various stocks. However, individual stocks carry more risk than mutual funds investments.