Between stocks and mutual funds, which is the best? If you are a new investor, answering the question of whether to invest in individual stocks or in mutual funds is one of the hardest challenges you will ever face. Each option has its own upsides and downsides, and you need to understand all of these in order to make a decision you will be proud of.
In this article, I will be discussing the differences between stock investing and mutual funds as well as the strengths and weaknesses of each. But before I proceed, I will define both terms (I’m sorry, I’ll assume that you are a complete newbie).
Stock investing is an investment practice, which involves buying individual stocks through a brokerage. In stock investing, investors manage their stocks by themselves and are responsible for whatever result their investment brings. A mutual fund on the other hand is an investment scheme, in which an investment company controls a pool of assets that regularly sells and redeems its shares.
In mutual funds investing, a fund manager actively manages stocks on behalf of investors. Aside the few differences suggested by the definitions, there are many other differences between stock investing and mutual fund investing. With that in mind, let’s now discuss the differences between both practices.
Stock Investing Vs Mutual Funds: Which is the Best?
1. Number and variety of stocks
Because mutual funds usually control a large number of stocks from various companies, they are automatically diversified. And they provide investors with lots of flavors, including sector based funds such as energy, retail, or technology, commodities, and foreign indexes. However, in individual stock investing, there is no diversification, as investors can only place their funds on stocks from only one company (in most cases).
2. Profit potential
Mutual funds generally hold a large number of funds with varying market performances. This means, while some stocks are appreciating, others may be crashing. This reduces the general profit potential of mutual fund investment.
As for individual stock investment, the performance of the single stock at stake determines the profit or loss that goes to the investor. So a marked appreciation of a stock results in huge profits; since there are no other stocks that may depreciate to bring about a profit drawback.
3. Risk potential
Each equity in a mutual fund comprises only a small percentage of the fund’s overall portfolio. So, a marked depreciation in a single stock will have little negative effect. For example, a mutual fund may have a global brand such as Samsung as one of its top holding, but a sharp drop in Samsung shares will barely affect the mutual fund. This is because Samsung shares may comprise no more than 2% of the fund’s overall portfolio.
In individual stock investing on the other hand, there is higher risk potential, as the investor invests only in shares from a single company. In other words, because the overall portfolio in this case comprises 100% shares from a single company, a drop in the value of the shares will result in huge losses.
4. Activity level
Experienced fund managers control mutual funds. So, you don’t have to monitor your funds, as they are being handled on your behalf by capable hands. Regarding individual stock investing, the investor is actively involved in the management of his or her funds.
5. Number of shares
Most of the time, mutual fund investors cannot define the specific number of funds they want to purchase. Instead, they only state the amount of money they are willing to invest in the mutual fund, and the brokerage will calculate the number of shares to be bought based of the day’s closing price.
(The share price of a mutual fund doesn’t fluctuate during the day). As for individual stocks, investors specify the number of shares they want to purchase and calculate the amount of money required to purchase that number of shares.
6. Time frame
For investors to make real profit from mutual funds, they need to wait for a longer period (in terms of years), as mutual funds tend to grow slowly and steadily over time. Individual stock investors can make huge profits within shorter time, depending on the performance of the shares they invested in.
If you are a new investor without much knowledge about how things work, or if you have some funds that you won’t need for many years to come, or if you are afraid of risks, or you don’t have the time to monitor your investment, then mutual fund investment is better for you.
However, individual stock investing would suit you better if you have in-depth knowledge of the stock market and various companies’ shares, or you can’t afford to part with your funds for too long, or you are not satisfied with the little profit that mutual funds bring, or you prefer to monitor your funds yourself. If I am to air my views, I believe individual stock investing is preferable because with every active investment you make, your financial IQ increases and your experience grows.