May 25, 2023
Mutual Funds vs. Stocks: Which Is Better for Beginner Investors?
|What’s the difference between mutual funds and stocks?|
A stock is a sliver of ownership in a single company, while a mutual fund is a basket of many stocks and other assets from multiple companies. While investing in a single stock means investing in one company, investing in a mutual fund means buying into many investments at once – all within a single investment.
As a new investor, you might be weighing the difference between mutual funds and stocks. While both can help you earn solid returns, mutual funds are generally considered a safer investment than individual stocks.
A mutual fund is a pooled investment containing many stocks and other assets within a single fund, while a stock is an investment in a single company. By divvying up your investment across hundreds of companies instead of just one, mutual funds spread out your risk and add more diversification to your portfolio than a single stock would.
Ultimately, choosing between stocks vs. mutual funds depends on your investment goals. Both can be a smart addition to your portfolio, but the right choice for you depends on factors like your risk tolerance and time horizon.
Ready to learn the difference between mutual funds and stocks? Here’s a breakdown of the key differences and pros and cons to know.
Mutual funds vs. stocks: key differences
What’s the difference between mutual funds and stocks? Purchasing a stock means buying a small piece of ownership, or a share, in a company. When you buy a stock, your returns are based on the performance of that company. When the company does well, the stock price typically goes up, and stockholders who own shares reap the benefit.
A mutual fund is a basket of hundreds of stocks, securities, and other assets within a single fund. With a mutual fund, you’re investing in the many different shares that make up the single fund, giving you broader market exposure compared to a single stock.
Since an investment fund manager actively manages mutual funds—the individual responsible for implementing a fund’s investment strategy and making the behind-the-scenes trading decisions—they make a convenient investment avenue for beginners who would rather leave the research and stock-picking decisions to an expert.
Here’s a quick overview of the difference between stocks and mutual funds, based on key investment characteristics:
- Diversification: Limited
- Risk: High—performance based on a single company
- Cost: No ongoing fees after purchase
- Customization: High—you choose the stocks you want
- Beginner friendliness: Low—intensive company research required
- Diversification: Instant diversification
- Risk: Low—offers protection through diversity
- Cost: Higher ongoing management fees
- Customization: Minimal—a fund manager chooses what goes into the fund
- Beginner friendliness: High—no research or prior knowledge required
For a more in-depth comparison of individual stocks vs. mutual funds, we break down the pros and cons of each below.
Pros and cons of mutual funds
|Instant diversification||No say in which companies make up the fund|
|Minimizes risk||Can have higher costs|
|Actively managed by a professional||Less tax efficient|
|Convenient; no research required||Trades allowed only once per day|
For new investors, mutual funds are ideal thanks to their low barrier to entry and instant diversification.
Mutual funds are an ideal investment because they offer instant diversification and carry less risk than a single stock.
- Instant diversification: Because you get exposure to an array of companies, industries, and sectors, mutual funds instantly diversify your portfolio which can help to reduce the impact of a single investment on your overall portfolio.
- Minimizes risk: It’s unlikely that every company within a mutual fund will go down at the same time, protecting your portfolio from volatility.
- Convenient: Mutual funds allow new investors to leave the complex research and stock-picking decisions to an expert.
- Can be affordable: While actively managed mutual funds may have higher fees, passively managed mutual funds like index funds or ETFs typically have lower fees.
In comparing stocks vs. mutual funds, here’s why mutual funds are often the better investment: rather than betting on the ups and downs of a single company or industry, your holdings are spread across an array of companies, industries, and sectors. If one company in the fund has a bad quarter, its performance can be balanced out by other companies that are doing well. In short, they’re less risky overall.
While mutual funds are a convenient way for investors to get broad market exposure, they still come with a few drawbacks.
- Less control for investors: Since a fund manager decides which stocks and other assets make up the fund on your behalf, you have no say in what’s included.
- Can have higher costs: Mutual funds often charge management fees, which can eat into investment returns over time. Actively managed funds typically have higher fees compared to passively managed funds like index funds.
- Less tax efficient: Due to the activity and active involvement of a fund manager, mutual funds can generate more taxable events and higher capital gains.
- Trades only allowed once per day: Mutual funds can only be bought or sold at the end of a trading day, limiting the ability to respond quickly to market changes for active traders.
While mutual funds only allow trades once per day, there are other types of funds like ETFs or index funds that offer many of the same advantages. With an ETF, investors can buy and sell shares throughout the day, based on the fund’s real-time share price. They also tend to have lower fees than mutual funds.
Pros and cons of stocks
|Potential for higher-than-average returns||Higher risk and volatility|
|Full control over which companies you invest in||Potential for higher-than-average losses|
|No management fees||Requires time-intensive research for each individual stock|
Stocks are an attractive investment namely due to the potential for outsized returns, but there are some drawbacks to be aware of.
When quarterly revenue and profits are high and the stock price increases, stocks can provide higher-than-average returns compared to the overall market.
- Potential for outsized gains: Depending on the company’s performance, you could see higher-than-average returns.
- Full control over which companies you invest in: Buying individual stocks means there’s no fund manager involved, so you’re in control of every trading decision.
- No management fees: By self-managing your own stock picks, you avoid the management fees you’d have to pay for an actively managed fund.
While the potential gains of individual stocks are higher, so are the potential losses, as explained below.
Even though it’s possible to see substantial returns from individual stocks, stock prices can be volatile, meaning they may rise and fall quickly. Stocks are also a more ambitious and time-intensive undertaking since you’ll have to research the stocks of individual companies yourself.
- Higher risk and volatility: Betting on a single company increases the risk and volatility of your investment.
- Potential for outsized losses: With stocks, the potential for higher returns comes with the potential for bigger losses if the company underperforms.
- Requires time-intensive research and investment knowledge: Knowing what company to invest in requires intensive research—investors must analyze earnings reports and market performance, and make predictions about future price movements.
- Low diversification: Allocating your portfolio toward one or two companies doesn’t provide diversification.
In short, when you buy a single stock, you’re putting all your eggs in one basket. Your fortunes rise and fall with the company’s performance. This makes for a more volatile investment, meaning that it’s more likely to have big gains or losses—sometimes even in the course of a single day.
Mutual funds vs. stocks: which is the better investment?
For long-term investors looking to build wealth over time, mutual funds are a dependable investment, as they aim to reduce overall risk—an important factor in a successful retirement portfolio. They’re also well suited for beginner investors who want to reap the benefits of the stock market without any prior investment knowledge.
For investors who want to capture the potential growth of a particular company, individual stocks offer the potential for larger returns. Investors who go this route must be able to stomach more risk and be confident in their ability to analyze individual stocks.
Investing in mutual funds vs. stocks comes down to your investment goals and risk tolerance. The main difference between stocks and mutual funds is the number of eggs in your basket—and diversification is usually considered a solid investment strategy.
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FAQs about mutual funds vs. stocks
Still have lingering questions about stocks vs. mutual funds? Find the answers below.
Are mutual funds safer than stocks?
Generally, yes. Since diversification is a risk-management strategy, the instant diversification that mutual funds provide lowers their overall risk compared to individual stocks.
Why would someone choose a mutual fund over a stock?
The most common reason someone would choose a mutual fund over a stock is that it’s a convenient, hands-off way to profit from the stock market without any active management on their part. It’s also an easy way to diversify your holdings, which isn’t the case when you purchase a single stock.
Is it better to invest in stocks or mutual funds?
Whether it’s better to invest in stocks or mutual funds depends on your individual preferences and circumstances, as stocks offer potentially higher returns but come with higher risk and require more active management, while mutual funds provide instant diversification, convenience, and professional management at the cost of potentially lower returns.
Do mutual funds outperform the stock market?
The performance of mutual funds compared to the stock market can vary widely, as some mutual funds may outperform the market over certain periods, while others may underperform. It ultimately depends on factors such as the fund’s investment strategy, the skill of the fund manager, and market conditions.
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