Email FacebookTwitterMenu burgerClose thin

Mutual Funds vs. Stocks: Key Differences

Share

Mutual funds and stocks each offer specific types of advantages to investors. In general, stocks tend to offer higher returns while mutual funds tend to offer greater stability. The right one for you will depend on your goals, risk profile and investment strategy. To find out which works best for you, here is a comparison of mutual funds and stocks. Because an investment portfolio often has a mix of stocks and mutual funds, consult with a financial advisor to find the best mix for you.

Stocks vs. Mutual Funds: Overview

Mutual funds and stocks offer two pathways for an investor to purchase securities. They share some similarities. You can purchase either of these publicly traded assets through similar means. But while both require research and come with their share of risks and rewards, they are significantly different.

A mutual fund is a collection of securities bundled together and traded as one purchase. These grouped-together securities may be individual stocks, bonds or other assets. Multiple investors pool their money to invest in these funds handled by professional money managers. They, in turn, allocate the collected investments that generate income or capital gains for the investors. Each one functions according to designated objectives and planned structure. Ultimately, investing in a mutual fund means purchasing a portion of one larger and diversified portfolio.

In contrast, stocks are simpler. A company sells a share of ownership to investors, the value of which fluctuates. Market influences and company finances and operations contribute to the overall price for a specific stock. Sometimes companies pay out a portion of earnings to shareholders in the form of dividends. The investor can then use these to reinvest or cash them.

While stocks tend to be riskier, they come with a greater chance for higher returns. In contrast, the mutual fund mitigates risk, thus protecting investors from loss but at the cost of smaller returns.

Comparison of Investing in Stocks vs. Investing in Mutual Funds

Investing in stocks and mutual funds are two different approaches to growing wealth, each with its own characteristics, as outlined above. Here are the major differences that anyone should be aware of before investing:

  1. Ownership and control: When you invest in stocks, you directly own shares of individual companies and have complete control over buying and selling them. With mutual funds, you invest in a pooled fund managed by professionals who make investment decisions on your behalf.
  2. Risk and diversification: Stocks tend to be riskier because they depend on the performance of a single company. Mutual funds, on the other hand, offer diversification by investing in a mix of stocks, bonds, or other assets, which helps reduce overall risk.
  3. Management style: Stock investments require active management, research, and monitoring to make informed decisions. Mutual funds are managed by professionals, making them a more passive investment option for individuals who prefer a hands-off approach.
  4. Costs and fees: Investing in individual stocks typically incurs trading fees and commissions (though many platforms now offer commission-free trading). Mutual funds come with management fees, expense ratios, and sometimes sales charges, which can reduce overall returns over time.
  5. Returns and performance: Stocks have the potential for higher returns but come with increased volatility. Mutual funds generally provide more stable, long-term growth, but the returns may be lower due to diversification and management costs.
  6. Liquidity: Stocks can be bought and sold at any time during market hours, providing greater liquidity. Mutual funds are typically traded once a day at the net asset value (NAV), making them slightly less flexible in terms of immediate buying and selling.
  7. Investment strategy: Stock investors need to conduct their own research and build their own portfolios. Mutual fund investors rely on fund managers to choose and balance investments based on the fund’s objective.
  8. Minimum investment requirements: Some stocks can be purchased with relatively small amounts of money, while mutual funds often have minimum investment requirements that can range from a few hundred to several thousand dollars.
  9. Tax implications: Stock investors can manage their tax liabilities by timing sales and choosing tax-efficient strategies. Mutual funds may trigger capital gains distributions, which are taxable even if the investor does not sell their shares.
  10. Time commitment: Investing in individual stocks requires significant time for research, monitoring, and decision-making. Mutual funds are designed for investors who prefer a more passive approach with minimal time commitment.

Ultimately, choosing between stocks and mutual funds depends on an investor’s risk tolerance, investment knowledge, time availability and financial goals. Let’s take a closer look at two of the most important aspects of the comparison for many people now, investment time and how much it might cost you.

Stocks vs. Mutual Funds: Time and Costs

If stocks are your investment of choice, you need a large number to create a diverse portfolio. So, an individual investor may find that costs add up quickly when trading multiple stocks. However, if these purchases are done with an online brokerage that offers commission-free trading, those costs go away. What doesn’t go away, though, is the time it takes to research each stock that ends up in one’s portfolio.

Unlike stocks, mutual funds charge operating expense ratios. They can range from less than 1% to more than 4% or even 5%. In addition, some mutual funds charge annual fees, redemption fees and front-end loads. These fees can be consequential and compromise an investor’s total returns. On the other hand, a mutual fund investor often has to spend less time making decisions about which security to buy.

Upsides of Stocks and Mutual Funds

"Mutual Funds" written on a piece of paperStocks offer capital appreciation to investors as share prices rise. Of course, the opposite is true when share prices fall. For example, consider investing in individual stocks. One of the companies you own shares in might experience a reputation-damaging scandal, thus sending the stock’s price spiraling downwards.

Mutual fund owners normally don’t experience the same kind of volatility. Fund performance generally stays relatively steady and safe but modest, at least compared to stocks. Since mutual funds create instant diversity in your portfolio, you don’t experience hits to the fund as hard as someone who owns stocks alone. Diversity is the key to protecting your investments from major losses because, like mutual funds, it allocates your money in multiple areas.

You can diversify a portfolio with only individual stocks. It would just take a lot of time and dedication to research since each choice must be made strategically.

Which One Is Right for You?

Investing in stocks is best suited for individuals who have a higher risk tolerance, a good understanding of the market, and the willingness to actively manage their investments. Stock investors typically seek higher returns by purchasing shares of individual companies, which allows them to benefit from price appreciation and dividends. However, this approach requires thorough research, time commitment, and the ability to handle market fluctuations.

On the other hand, investing in mutual funds is ideal for those who prefer a diversified, professionally managed investment with lower involvement. Mutual funds pool money from multiple investors to buy a variety of stocks, bonds, or other assets, reducing risk through diversification. This option is well-suited for beginners, long-term investors, and those who prefer a hands-off approach while still participating in market growth.

While mutual funds typically have management fees, they offer a more stable and convenient investment strategy compared to picking individual stocks. Ultimately, the choice between stocks and mutual funds depends on an investor’s risk tolerance, financial goals, and level of experience in the market.

Bottom Line

Asian investorStocks and mutual funds are promising investment options for any investor. Each comes with unique benefits, such as built-in diversification versus control over your choices. While generally more volatile than funds, stocks tend to deliver greater returns, whereas mutual funds protect your money but often pay smaller returns. However, they each have their downsides as well. In most cases, the best investment strategy involves a diversified portfolio.

Tips for Investing

  • While online platforms have their place, sometimes you just need in-person guidance. A human financial advisor can provide in-depth advice that conforms to your unique needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s matching tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Make sure you run the appropriate numbers through a retirement calculator to confirm your estimates of what you’ll need after you stop earning money and how much you can safely withdraw from accumulated funds.

Photo credit: ©iStock.com/svetikd, ©iStock.com/spxChrome, ©iStock.com/Asia-Pacific Images Studio