Stocks vs. Mutual Funds

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The recent rise in the popularity of mutual funds has brought them under wider and more substantial scrutiny. Many people are discovering that mutual funds are an excellent investment option, but stocks are still better.

Plain English

A mutual fund is a mass portfolio that has been collected by a mutual fund manager and is professionally managed for its owners or shareholders.

A mutual fund can be composed of any combination of investments, or it can focus on only one investment vehicle ”stocks, for example. In fact, the vast majority of mutual funds are totally composed of stocks, or at least contain some stocks in their composition. It would appear, then, that investing in a mutual fund composed of stocks would differ only slightly from investing in the stocks themselves .

To some extent, this is true. But because mutual funds come as a package deal, there are substantial differences between the two as investments.

First, you lose a lot of control over the mix of your investments. When you purchase a share of a mutual fund, you purchase a portion of each of the stocks in the fund. You cannot sell off any stock in the mix with which you are not comfortable, nor can you add stock that you think might be a valuable asset to the fund. Of course, you could always buy that stock on your own, but then you would be purchasing stock instead of mutual funds. The ability to select stock individually has become particularly important with the advent of social investing. Staunch environmentalists, for example, may wish to purchase stock only in those companies that are environmentally friendly. This might prove difficult to achieve with the broad number of securities within a mutual fund.

Plain English

Social investing is a relatively new concept whereby factors such as the nature of a company's product or service and its reputation for diversity and ecological responsibility come into play when determining whether its stock is a worthy investment.

In addition, theoretically you could never make the same amount of money with a mutual fund that you could if you purchased the stock contained in the mutual fund's mix directly. This is because a portion (albeit a small portion) of the money you spend to purchase a share of the mutual fund is used to pay the people who manage the fund, rent the building, and otherwise cover any expenses associated with maintaining the fund. These same charges wouldn't apply if you purchased the stock directly. I said "theoretically" because the broker fees you would pay to purchase shares of all those stocks would probably quickly overtake any management fees you would pay to a corresponding mutual fund.

TIP

Stocks by default provide higher returns than mutual funds since management fees are not levied on stock owners. Mutual funds, however, offer a higher degree of diversification.

For that reason, mutual funds, like bonds and cash, do have a place in the investment arena. By purchasing a share of a mutual fund, you as an individual investor can place your money in much the same circumstances as the money of a large investor. By investing in a mutual fund, you can spread a minor investment over several stocks, thereby diversifying your holdings and mitigating risk. At some point, however, the safety of the mutual funds will become constraints that will eventually make you move on to purchasing individual stocks.

The 30-Second Recap

Different investment vehicles carry risks particular to them and may complicate comparison to stocks.
Stocks provide the highest returns over cash investments but cash investments are the most secure.
Stocks historically provide higher returns than bonds but investment in bonds is more secure.
Stocks can provide higher returns than mutual funds but lack their diversification.
As an investment's ability to produce higher gains grows, so, too, does the risk of losing your money.

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