Both stocks and mutual funds have their benefits. Deciding which fits best with your investment style highly depends on three factors: time-frame, risk-reward, and expenses. At first, you will need to determine how much risk you can tackle versus how much return you want. The thing is, if you wish for a higher return, then you should accept a higher risk.
In this instance, the saying “time is money’’ proves annoyingly true since it depends on how much you have (and willing to spend) to investigate your investments. The amount of time you expect to spend researching fund prospectus or financial statements will heavily impact which of two investment options is right.
Another factor is what type of expenses and fees you are willing to face. This might also include alterations in tax implications. We suggest you consider these factors in mind as you learn more about these popular investment options.
Stocks or Mutual Funds?
If you invest in a stock, you’re basically purchasing a share of one organization. On the other hand, a mutual fund offers more variation by combining many company stocks in one investment. Understanding the difference between mutual funds and stocks helps to break down what exactly each investment type works.
- Mutual Funds
Investing in mutual funds comes with many varieties, including those that focus on a variety of classes, those that focus on dividend stocks, and those that seek to mimic an index fund. This type of investment serves as a substitute for investors who can’t afford an individually managed account for all intents and purposes.
Mutual funds are made when investors with a smaller amount of capital unite their financial powers and then hire a portfolio manager to handle the consolidated pool’s portfolio – subsequently purchasing different bonds, stocks, or other securities in a way consistent with the fund’s catalog. As such, each investor receives their respective part while sharing the expenses, which appear in something known as the mutual fund expenses ratio.
If you purchase a stock, you own a share of the company. Thus, being a partial owner means you will make money in two ways. The first capital you’re likely to notice is the dividend payment. Stocks that provide dividends must pay out part of their profits to investors on an annual or quarterly basis. If you’re the shareholder, then you will receive a constant stream of taxable income as long as you own that stock.
Another way to make money from stocks is by selling them. In that case, your profit will make the difference between the purchase price and selling price (minus charges such as commissions). Gaining from the sale of a stock is a type of “capital gain.” Stocks trade uninterruptedly, and the prices change throughout the day.
The amount of time you spend on research and whether you have enough patience to learn how to evaluate your future financial statements matters more than you think. Simply put, if you want to save time, you should either find the best investment companies or go with a mutual fund.
If you think you are best suited for stock investing, then you need to research each company you consider adding to your agenda. You should also learn how to read financial reports, find out how much capital the company makes, how the company plans to grow earnings, and where the income comes from. In doing the research you will easily determine the value of the company and where the stock price is proportional to that value.
We recommend novice investors stay on top of how the overall company is doing. A business can be making all the smart decisions, but that doesn’t hinder the stock from declining if something happens to the economy.
The effort is multiplied if you want to maintain a well-balanced and multiplied portfolio. Therefore, it’s recommended to select companies from a wide range of industries with different strategies and sizes. There is no successful investment without a bit of effort and research. So, when we talk about time and investment, we mean you should take that time to investigate dozens of businesses to find a few good ones.
As for mutual funds, there’s a lot less work to do. In that case, you will only need to deduce the type of mutual fund you want – whether it’s a fund for a target-date fund, or an index fund, or a specific sector. You should also investigate the historical performances of the mutual fund and compare it to similar funds that track the same benchmark or index.
Balancing Risk with Reward
For a novice investor, stock can be a lot riskier than mutual funds. This fact mainly comes down to something known as “diversification.” Why? Because the more diverse your assets are, the less exposure to risks you get. Yet, limiting your risks may also limit the returns you eventually receive from your investment.
If you choose mutual funds, then you will achieve diversification in two ways:
- Depending on the mutual fund you’re considering, it may contain a mix of bonds and stocks. Bonds are known to be a lot safer than stocks, therefore, mixing them into your agenda will help reduce risks.
- Even when a mutual fund holds 100 percent stocks, that doesn’t mean all those stocks belong to one company. As a safety measure, if a single business gets hit with a scandal that causes a stock to crash, the mutual fund investors won’t be affected as hard as the investor that only owns that business’s stock.
Fees and Costs
If you’re already convinced that extra fees and costs will hinder your investment, stock investing is the way to go. You will still have to pay taxes on capital gains and dividends, but apart from that, the only fees are those that your brokerage firm will apply to your trade offers.
Extra tip: Regardless of the investment type you choose, you can reduce the impact of taxes by using tax-advantaged retirement accounts like Roth IRA.
To sum it up, if you want to reduce your research time and risks, and you’re willing to take on some extra fees and costs for that convenience, then a mutual fund may be a better option. On the flip side, if you like taking risks and divining deep into financial research, and dodging fees, then stock investing may be a better investment choice.