Are Stocks or Mutual Funds Smarter Investments?

If you are a growth investor, one decision you must make is to invest in stocks or mutual funds. Each has its benefits and drawbacks. Let’s examine the pros and cons of each to determine which is a better fit for you.

Cost

When you buy individual stocks, you pay commissions but they are usually very low – especially if you use a company like Scottrade. You could easily trade thousands of shares for less than $10.

You could of course buy any number of mutual funds without paying any commission at all – but you’d have to pay ongoing management fees. Ongoing management fees can be very low (less than .15% per year) or very high (greater than 3% per year). This depends on the mutual fund you buy. You must dig into the mutual fund prospectus in order to really know what it costs you to own the fund.

Bottom Line.

From a cost standpoint, stocks are generally much cheaper to own specifically because they don’t charge ongoing management fees.

Ease of Use

Both stocks and funds are pretty easy to use. Using an online broker you can buy or sell stocks or mutual funds in a snap. No big deal there.

What is important when you think about the ease of use is the investment strategy you use to guide your investments. Remember I told you that mutual funds charge ongoing management fees while stocks don’t? Well the reason for this is that the mutual fund manager does all the research for you. It’s true that you must come up with a good strategy to buy and sell your funds but that’s far easier than to develop a stock picking strategy.

And when it comes to individual stocks, you must do the research yourself. You can’t just buy a stock and hold on to it forever. In the vast majority of cases, stocks that are hot today will become dogs if you give them enough time. That’s why you must do a great deal of research when you consider which stocks to buy and sell.

And you must continue doing your research to make sure that the stocks you own today are still solid. This will require you to develop expertise in stock research and that in turn is going to require a big time commitment from you as well.

Bottom Line.

For most people mutual funds are a far more efficient way to invest. They require less research upfront and on an ongoing basis.

Volatility

When you buy a mutual fund, you own hundreds or thousands of stocks. Most people who hold individual stocks are far more concentrated than that. I’ve seen some people own up to 60 stocks. But most people own far fewer individual stocks than that. As a result of this concentration of capital, people who own individual stocks have to accept more volatility and risk.

If you own one fund that owns hundreds of stocks and one of those stocks goes belly up, you might see a ½% drop in your capital. You can survive that. But if you own 10 individual stocks and one goes kaput, you just lost 10% of your money. Ouch.
This is not to say that mutual funds or that diversification eliminates risk. As 2007 demonstrated, when the market is bad, almost all stocks fall. That impacts people who buy mutual funds as well as people who buy individual stocks.

Bottom Line.

Market conditions tend to impact all stocks (and the mutual funds that own stocks) but there are also business risks that impact specific stocks very differently than funds. Because your money is so concentrated when you buy individual stocks, you can expect much greater volatility and risk compared to owning funds.

Bottom Line Summary

Most people are better off with mutual funds or ETFs as compared to individual stocks. They are cheaper and safer once you consider all the time you save by not having to do a great deal of research that individual stock investors must do.

Owning individual stocks opens up the potential for you to hit a home run of course while funds do not really provide such an opportunity. Of course, every time you have the chance to hit it out of the park you also have the risk of striking out. Most people want base hits when it comes to investing and mutual funds provide that opportunity far better.

Where do you stand? Do you buy stocks or mutual funds…or both? Why?