Pros and Cons: Mutual Funds vs. Stocks - SmartAsset (2024)

Mutual funds and stocks each offer specific types of advantages to investors. In general stocks tend to offer higher returns while mutual funds tend to offer greater stability. The right one for you will depend on your goals, risk profile and investment strategy. To find out which works best for you, here is a comparison of mutual funds and stocks. Because an investment portfolio often has a mix of stocks and mutual funds, consult with a financial advisor to find the best mix for you.

Stocks vs. Mutual Funds: Overview

Mutual funds and stocks offer two pathways for an investor to purchase securities. They share some similarities. You can purchase either of these publicly traded assets through similar means. But while both require research and come with their share of risks and rewards, they are significantly different.

A mutual fund is a collection of securities bundled together and traded as one purchase. These grouped-together securities may be individual stocks, bonds or other assets. Multiple investors pool their money to invest in these funds handled by professional money managers. They, in turn, allocate the collected investments that generate an income or capital gains for the investors. Each one functions according to designated objectives and planned structure. Ultimately, investing in a mutual fund means purchasing a portion of one larger and diversified portfolio.

In contrast, stocks are simpler. A company sells a share of ownership to investors, the value of which fluctuates. Market influences and company finances and operations contribute to the overall price for a specific stock. Sometimes companies pay out a portion of earnings to shareholders in the form of dividends. The investor can then use these to reinvest or cash them.

While stocks tend to be riskier, they come with a greater chance for higher returns. In contrast, the mutual fund mitigates risk, thus protecting investors from loss but at the cost of smaller returns.

Stocks vs. Mutual Funds: Time and Costs

If stocks are your investment of choice, you need a large number to create a diverse portfolio. So, an individual investor may find that costs add up quickly when trading multiple stocks. However, if these purchases are done with an online brokerage that offers commission free trading, those costs go away. What doesn’t go away, though, is the time it takes to research each individual stock that ends up in one’s portfolio.

Unlike stocks, mutual funds charge operating expense ratios. They can range from less than 1% to more than 4% or even 5%. In addition, some mutual funds charge annual fees, redemption fees and front-end loads. These fees can be consequential and compromise an investor’s total returns. On the other hand, a mutual fund investor often has to spend less time in making decisions about which security to buy.

Upsides of Stocks and Mutual Funds

Stocks offer capital appreciation to investors as share prices rise. Of course, the opposite is true when share prices fall.For example, consider investing in individual stocks. One of the companies you own shares in might experience a reputation-damaging scandal, thus sending the stock’s price spiraling downwards.

Mutual fund owners normally don’t experience the same kind of volatility. Fund performance generally stays relatively steady, safe but modest, at least compared to stocks.Since the mutual funds create instant diversity in your portfolio, you don’t experience hits to the fund as hard as someone who owns stocks alone. Diversity is the key to protecting your investments from major losses because, like mutual funds, it allocates your money in multiple areas.

You can diversify a portfolio with only individual stocks. It would just take a lot of time and dedication to research since each choice must be made strategically.

Which One Is Right for You?

The right investment for you depends on your personal situation and goals. You need to identify your investment strategy, its time horizon, activity level and your risk profile, to decide on the right one.

Every investor should strive for a diversified portfolio. Mutual funds build that right into their structure, making them appealing to those who want security in their investments. Someone who wants a safe portfolio may also prefer a passive investment strategy. Mutual funds come with that option through their managers. They take on the hard work by researching and choosing which trades to make.Keep in mind: managers don’t do all the work. So you still have to monitor and rebalance your portfolio periodically.

In contrast, stocks typically require a more active approach. It is on the individual investor to analyze market data, compare prices and choose compatible stocks. That allows traders to have full control over the types of investments they make, which may suit them if they have particular preferences. However, it also demands a lot of attention. Stock investors have to put in a significant amount of time and effort to ensure they don’t lose out. On the other hand, this work may be worth it if you are interested in making more money.

The Takeaway

Stocks and mutual funds are promising investment options for any investor. Each comes with unique benefits, such as built-in diversification versus control over your choices.While generally more volatile than funds, stocks tend to deliver greater returns, whereas mutual funds protect your money but often pay smaller returns. However, they each have their downsides as well. In most cases, the best investment strategy involves a diversified portfolio.

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