Understanding Mutual Funds Versus Stocks

If you’re looking to invest for the future, piling your money into a traditional saving account won’t provide enough money for retirement. Most serious investors consider two main options for future savings – mutual funds or stocks. Mutual funds let investors participate in the market without the need for extensive research and knowledge, thus providing a passive form of investing. A fund manager guides the investor and ensures the best yields for the fund. If you’d like to have an active role in your investment, which includes some research and management of your portfolio, then individual stocks are the way to go. Both mutual funds and stocks provide higher returns on investments but carry specific advantages and risks. Consider the differences below.

Mutual Funds

If you’re just starting out with investing, mutual funds might be just what you need. Consider mutual funds as a diversified basket of investments that contain stocks, bonds and cash equivalents from various sectors – think finance, technology, children’s products and foreign indexes. Since the fund contains a large number of stocks, each equity contributes (or takes away) only a small percentage from the overall portfolio. For example, if one company suddenly does well on the market, there’s no guarantee of the fund growing as that specific equity might account for just a small percentage. The movement, o r lack of it, is both a benefit and a downside with mutual funds.

Mutual funds are ideal for long-term investments as they allow for slow and steady growth. Monitor the market to purchase shares when the prices drop and you’ll benefit from significant growth in your investment. You can also reinvest your dividends automatically to purchase more of the same shares, and you’ll avoid both capital gains tax (associated with cash dividends) and a brokerage commission for purchasing extra shares. Two real disadvantages with mutual funds are the fees and the tendency to follow the market up or down. Fees vary by account but generally include a fund manager fee, early withdrawal fees, initial purchase fee and a back-end fee among others. Index funds are passively managed mutual fund options that eliminate some of the fees common to traditional mutual funds.

Stocks

Stocks are riskier than mutual funds. However, the greater risk means a higher potential for returns. Before you pursue the high yields, remember the potential for loss is just as high as the returns. Also, stocks do not allow for diversification like mutual funds. If you don’t mind researching your stock options and managing your portfolio, after purchasing the stocks through a brokerage, you’ll pay fewer fees than those associated with mutual funds.

Like mutual funds, you can reinvest the dividends to avoid capital gains tax. Monitoring your stocks could be an emotional roller coaster if you’re new to this type of investing. Experienced investors offset the risks by building a strong portfolio to safeguard against the market’s volatility. Where mutual funds involve a passive approach, you must take an active approach to stocks by learning the terminology, rates of interest, commodity prices, earnings, potential for loss and much more.

Consult a financial advisor before committing to stocks or mutual funds especially if you’re uncertain what type of investment would meet your short and long-term goals.