Feb 14, 2022
Stocks vs Mutual Funds: What’s the Difference?
Both stocks and mutual funds can be part of a diversified portfolio. Learn their key differences to see how they might work for you.
Many investors ask, “Should I invest in mutual funds or stocks?” Spoiler alert: maybe both!
Here’s the key difference between stocks and mutual funds: A stock is a sliver of ownership in a particular company, and a fund is a basket of stocks or other securities. Bear in mind that investing in a single stock could be riskier than investing in a fund. As a general rule, it can be wise to diversify your portfolio to spread out your risk by investing in an array of stocks, bonds, and funds. Ultimately, deciding on stocks vs. mutual funds, or a mix of both, depends on your investment goals.
Individual stocks: just one egg in your basket
When a company goes public, or has an initial public offering (also known as an IPO), it sells stock, or ownership in its company, to the public for the first time. Stock in these public companies is sold in units called shares. Each share represents a claim on the company’s earnings and profits. There are currently over 4,266 public companies in the U.S. that sell their stock on stock exchanges.
Since an individual stock represents ownership of one specific company, when you purchase a share, you’re essentially making a bet on that company. When the company has a great quarter or year with strong revenue and profit, that can be reflected in the stock price, which would typically increase based on a strong quarter—and therefore return more value to investors who own shares of the company.
But what if that business has a bad year, with reduced revenue and profit? That’s likely to be reflected in its stock price, lowering the value of investors’ stake in the company.
In short, when you buy a single stock, you only have one egg in your basket. Your fortunes rise and fall with the company’s performance. That means your investment is potentially more volatile, meaning that it’s more likely to have big gains or losses—sometimes even in the course of a single day.
Funds: a full basket of eggs
There are several types of funds, but what they all have in common is that they invest in many different securities: stocks, bonds and other securities. Some funds invest in hundreds of companies simultaneously—and that’s the key difference between stocks and mutual funds (or any other kind of fund.)
Investing in a fund can potentially help you diversify by spreading your investment risk—it’s the difference tying your portfolio’s performance to the ups and downs of a single stock vs. a mutual fund that contains hundreds of stocks, all of which have different levels of risk and volatility. If one company the fund invests in has a bad quarter, or even a bad year, its performance could be balanced out by other companies that are doing well. That may be why funds are among the most popular investments out there—US investors poured a staggering $29.3 trillion into them as of the end of 2020.
Should you invest in mutual funds, you’ll find lots of different approaches. Funds usually invest by themes; some common ones include:
- Sector or industry: For example, some funds invest in clean energy or health care
- Investment risk profile: Aggressive funds accept more risk for the chance of bigger returns, while conservative funds aim to provide lower but more reliable income over time
- Company size: A fund might focus on large, small, or medium-sized companies, typically within a given category, such as growth or value
There are many different kinds of funds. You’re most likely to encounter mutual funds and exchange-traded funds (ETFs); they both take money from many individuals and invest it in a basket of securities. With mutual funds, the net asset value (NAV) of the fund—the value of all securities in the fund is determined at the end of each day, and its daily share cost is determined by that value. In contrast, investors in an ETF can buy and sell shares throughout the day, based on the fund’s real-time share price.
You may also hear the term index fund. Index funds are mutual funds or ETFs that invest in the companies represented in a stock index. You may have heard of the S&P 500 and the Dow Jones Industrial Average—those are stock indexes. An index itself is not a fund, and you can’t invest directly in one. Rather, an index uses a collection of stocks to gauge the performance of the overall stock market, or a sector of the stock market, over time.
Stocks vs mutual funds: What belongs in your basket?
So, whether you should invest in mutual funds vs. stocks comes down to your overall investment strategy and risk profile. 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.
That’s why the answer to the question: “Should I invest in mutual funds or stocks?” might be that you consider investing in both. By investing in an array of stocks and funds, as well as bonds, in both developed and emerging economies, you’ll have more eggs in more baskets, which can smooth out the market’s spikes and dips. Stash customers can invest in many individual stocks and ETFs. And with fractional shares, you can get started with any dollar amount.