Mutual funds vs. stocks: Which is the better investment?
Stocks and mutual funds are both popular types of investments, allowing investors to build portfolios and grow their wealth. However, even though mutual funds often contain stocks, mutual funds and stocks have different traits that can appeal to various investors with different goals.
Here are the key features, as well as pros and cons, of stocks vs. mutual funds.
Stocks vs. mutual funds
Stocks and mutual funds both offer ways to construct a portfolio, but there are differences in the way they operate, as well as what you can expect in the long run.
A stock represents a share of ownership in a company. When a company, like Tesla (TSLA) or Amazon (AMZN) does well, those who own shares receive the benefit. As the company grows the business, the stock price usually goes up along with it, giving investors the opportunity to sell shares for more than they bought them for.
Meanwhile, a mutual fund is a pooled investment that contains shares of many different assets. Many mutual funds include a wide range of stocks and bonds, often hundreds. When you buy shares of a mutual fund, you receive a slice of everything included.
Additionally, there are index mutual funds that track popular indexes like the S&P 500 that can be purchased at very low costs. Other funds might be actively managed, where a professional chooses what’s included in the mutual fund based on different goals like growth or income. Actively managed funds come with higher fees and have typically underperformed passive funds over long time periods.
You can purchase stocks and mutual funds through a brokerage account. Employer-sponsored retirement plans, such as 401(k)s, mostly invest in mutual funds, so you might already own these funds without realizing it.
The pros and cons of stocks
Stocks offer a potentially valuable way to grow your wealth and take advantage of big price moves, but they also come with some drawbacks.
Pros
- Easy to trade — Individual stocks are easy to trade through an online broker, and there are a number of apps that make the process intuitive.
- Potential for large gains — Depending on stock performance, you could see large gains. This could lead to more wealth down the road.
- Low trading costs — In many cases, stocks come with low trading costs. In fact, many brokerages don’t charge trading fees for individual stocks.
Cons
- Potential for large losses — While there is the potential for large gains, you could also end up with large losses if the stock price drops and doesn’t recover.
- Research takes time — It can be time consuming to research stocks and choose the assets that work best for your portfolio.
- Stress — Investing in stocks can feel like an emotional rollercoaster. It’s important to understand your own risk tolerance before you start investing.
The pros and cons of mutual funds
Mutual funds can provide some diversity in your portfolio, but they aren’t foolproof. Here’s what you should know.
Pros
- Can be low cost — Many mutual funds, especially passively managed index funds, can be low cost, meaning they don’t charge a large expense ratio, or fee. Additionally, some brokerages offer their own funds without trading fees.
- Instant diversification — Because you’re investing in a basket of assets, you have instant diversification, and therefore lower risk, and don’t need to buy multiple individual stocks to diversify your portfolio.
- Can be less stressful — In some cases, investing in mutual funds can be less stressful than investing in stocks. Because you own a diversified portfolio of stocks, the fund is likely to be less volatile than if you just owned a handful of stocks on your own.
Cons
- Some funds have sales “loads” — There are mutual funds that charge a fee when you buy or sell shares. These sales loads can cost you before you even start investing.
- Can be high cost – Some funds charge a high expense ratio, sometimes above 1 percent of your investment in the fund annually, but lower-cost funds are available.
- May not be tax-efficient — If the mutual fund has sold assets and seen a gain, you might see distributions that create a taxable gain. So even if you haven’t sold your mutual fund shares, you could still be subject to capital gains taxes.
- Could underperform the market — If you have an actively managed mutual fund, or a fund that is managed by a team of traders, it might not perform as well as the market and you could even lose money. The expense ratios are typically higher for actively managed mutual funds, too.
Stocks vs. mutual funds: Which is a better investment?
Whether stocks or mutual funds are better for your portfolio depends on your personal goals, risk tolerance and time horizon.
For many investors, it can make sense to use mutual funds for a long-term retirement portfolio, where diversification and reduced risk are important. For those hoping to capture value and potential growth, individual stocks offer a way to boost returns, but come with more volatility.
For beginners who have a small amount to invest: Starting with index mutual funds and making regular contributions can be an effective way to build a portfolio. Later, after becoming more experienced, consider branching out into individual stocks. Carefully consider your goals and use investments to create a strategy designed to help you get there.
If investing in the stock market feels too risky for you, consider these low-risk investments for your portfolio.
Bottom line
Stocks represent shares in individual companies while mutual funds can include hundreds — or even thousands — of stocks, bonds or other assets. You don’t have to choose one or the other, though. Mutual funds and stocks can both be used in a portfolio to help you grow your wealth and meet your financial goals. Carefully consider how each might fit your needs and personal investing style.
You might also consider investing in exchange-traded funds, or ETFs. When comparing mutual funds vs. ETFs, you’ll notice a lot of similarities, but there are differences too. Be sure to do your research before investing.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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