Investing is one key way to build your wealth and reach your financial goals. (Hi, retirement.)And one easy way to get started is by buying into a mutual fund.
What’s a mutual fund?
It’s a type of investment that lets you buy a collection of stocks, bonds, or other securities. That means buying just one share of a mutual fund spreads your money out across a lot of different investments.
Psst…mutual funds really come in handy for stocks or bonds that might be difficult to purchase solo. Example: Shares of big companies like Amazon and Tesla may be out of your price range, but a mutual fund gives you the chance to earn a slice of both without breaking the bank.
Mutual funds vs. individual stocks: Which are better?
One investment type isn’t necessarily better than the other. But there are a few key differences you should consider:
Investment risks and rewards
It’s possible to get a return with either one. But mutual funds can be a less risky option, especially for beginners. Because (see above) they offer automatic diversification. Investing in an individual stock, on the other hand, means putting all those dollars into one basket.
But how risky a mutual fund is really depends on what’s inside.Read: A tech-stock fund is likely going to come with greater risks, and offer greater potential rewards, than a municipal-bond fund. (Hint: The latter invests in government-issued debt, i.e. a pretty safe bet.)
When you invest in mutual funds, you leave the portfolio management up to the professionals. Each fund has a manager or team whose literal job is to take the lead when it comes to investment selection and making all the tough buy and sell decisions. They might even have a whole company of analysts and in-depth resources to back them up.
With individual stocks, the management is on you. And if you want to do your due diligence, that means a lot of homework. As in, researching the ins and outs of each and every stock you’re interested in.And watching for when it’s time to buy… and then sell. And executing those trades yourself.
Trading fees, expense ratios, and other investing costs
Most brokerage firms charge per trade. Which makes buying 50 different stocks pricey vs. investing a single mutual fund that can hold hundreds of different stocks.
Mutual funds do come with their own costs though. Annual charges (or expense ratios) are assessed as a percentage of your investment. Costs average 0.2% for passively managed funds, or between 0.5% and 1.5% for actively managed funds. Funds can also come with other fees, like when you buy or sell shares.
Investors have to pay taxes on investments whenever they sell for a profit, aka realize a gain. With stocks, you’re likely to know (and have control over) when you make a winning sale. Not so much with mutual funds. Because, remember, the pros run that show. That means they control the trading — along with how often the fund realizes and gets taxed on gains. And they pass it on to shareholders. Even if you never sell any shares.
What’s the average mutual fund return?
Pro tip: Check out the fund’s returns over different time periods vs. its benchmark to help gauge its general performance. But keep in mind, just like with any other investment vehicle, there’s no such thing as a guaranteed return. And how it’s done in the past doesn’t necessarily tell you anything about how it’ll do in the future.
So should I invest in mutual funds or stocks?
The right investment for you depends on your individual financial goals and risk tolerance. Think: Are you in it for the highest possible returns as quickly as possible, no matter the risk? Or are you ok with your money growing over time with added safety?
It also depends on your investment account. In a 401(k), you might only have mutual funds to choose from.Individual stocks might make more sense in a tax-advantaged Roth IRA than in a taxable account.
And you don’t have to choose one investment or the other. Mixing and matching might work best for your overall portfolio.
Mutual funds can be a great way to diversify your portfolio. But all investments come with risk, and returns aren’t guaranteed. Be sure to base your investment strategy on your personal financial goals.