You want to invest, but where do you start? You hear all of these terms including mutual funds and stocks. Which is better?
Which has a lower risk?
Will one provide a higher return than the other? These are all questions investors have.
Keep reading to learn the difference between the two most common investments and how they may help (or hurt) your portfolio.
What are Mutual Funds?
Mutual funds are investments you go into with hundreds of other investors. Mutual fund managers pool the funds from all the investors and purchase a variety of investing that may include stocks, bonds, and other assets.
You buy a portion of the portfolio by paying the net asset value. This is the total value of the portfolio divided by the number of shares. The price varies as the underlying assets’ prices change, such as the value of the stocks and bonds.
Actively managed mutual funds are run by portfolio managers that buy and sell assets from the fund. The idea is for the mutual fund to meet or beat its benchmark, which is usually the S&P 500. Mutual fund performance should be based on its long-term performance and not short-term, as we’ve all seen the market can get volatile quickly, but it rarely lasts.
What are Stocks?
When you buy a share of stock, you buy a part of the company, which means you have ownership in the company. If the stock’s price goes up, you can sell it for a profit (capital gains). If it goes down, you lose money, but you don’t have to sell it. Like mutual funds, holding onto stocks for the long term provides the most significant results.
Many stocks also pay dividends or a portion of the company profits to its shareholders. Typically they pay dividends quarterly and you can reinvest the dividends or take the payment.
Which is Better Stocks or Bonds?
Deciding between stocks and bonds is a personal decision, but here are a few thoughts to get you going:
- If you want to create your own portfolio and have your own say in what’s in it, buy stocks. You can choose which companies you invest in, and which stocks you buy and sell at any given time.
- If you want a portfolio created and even managed for you, mutual funds are a better choice. Mutual funds are already diversified and they provide a hands-off investment that you don’t have to manage outside of buying the mutual fund itself.
- Stocks have commission every time you buy or sell them. If you do a lot of buying and selling, you’ll have large commissions to pay, which eat away at your capital gains and should be considered in your strategy.
- Mutual funds have annual expense ratios, which is the charge for the manager to oversee the fund. There may also be sales loads or transaction fees when you buy or sell mutual funds.
- Mutual funds often have minimum investment requirements starting at $1,000. They only trade once per day as they aren’t an actively managed fund like stocks.
- Stocks don’t have minimum investment requirements outside of the price of a share. If you don’t have enough to buy a share, you can’t invest in the stock. But, there isn’t a dollar amount minimum you must invest.
What Type of Investor are You?
As you choose between stocks and mutual funds, think about the type of investor you are. Are you okay with risk, or do you need to really minimize it? Can you handle someone else overseeing your portfolio or do you need to do it yourself?
Are you okay with annual fees, or would you rather pay an upfront commission and another commission when you sell?
The answer to these questions will help you determine what’s right for you as no two investors are the same. While many advisors promote mutual funds because of their diversity and lower risk, stocks are a great option if you can stand the risk.
Ideally, diversify your portfolio by filling it with mutual funds, stocks, bonds, and even real estate. Try to avoid investing all in one industry or type of investment. When you diversify, you help offset those investments that really lost value with investments that did okay. While it’s not perfect, no investment is, but diversifying your portfolio gives you the best-case scenario.