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Mutual Funds vs. Stocks: Key Differences & Which Investors Should Pick

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updated: October 17, 2023

If you're new to investing, you might wonder whether stocks or mutual funds are the best investments for beginners. When you invest in a stock, you buy a share of a single company, whereas a mutual fund is a collection of stocks, bonds, or other securities.

Mutual funds are generally considered a safer investment than stocks because they offer built-in diversification—something that helps mitigate the risk and volatility in your portfolio. On the other hand, some stocks may offer higher earnings potential, which can help you grow your wealth and reach your financial goals faster. However, betting on a single stock is far riskier than investing in a well-diversified basket of assets. 

Ultimately, deciding between stocks versus mutual funds comes down to your investment goals and risk tolerance. Here are the key features of stocks and mutual funds to help you decide which investment may be right for you.

Mutual funds vs. stocks: key differences

StockMutual fund
What it is
A share in one company
A portfolio of investments
Investing style
Active
Passive
Who makes decisions
Investor
Professional fund manager
Costs
Commissions when you buy and sell; no ongoing fees after purchase
Annual expense ratios; may have sales loads, redemption fees, and transaction fees
Diversification
Only as part of a well-diversified portfolio
Built-in diversification in a single investment
Risk
Higher; performance is tied to a single company
Lower; risk mitigated through diversification
Customization
High; you choose the stocks you want
Low; a fund manager chooses the investments
How it trades
During regular market hours
Once per day
Beginner friendliness
Low; you do your own research and analysis
High; a fund manager does the research and analysis
Taxes
You control capital gains by timing when you sell
You can owe capital gains taxes even if you don’t sell your shares

Pros and cons of mutual funds

Mutual funds can bring instant diversification and stability to your portfolio, but they may not be suitable for every investor. Here are the benefits and drawbacks to consider. 

Pros

  • Built-in diversification:  A single mutual fund holds a broader range of investments than most individuals could afford to buy.
  • Professional management: A professional fund manager (or team of pros) researches the companies, chooses the investments, and monitors the portfolio's performance. 
  • Attractive returns: High-performing, large-company stock mutual funds have produced returns of up to 12.86% over the last 20 years, according to Nasdaq.  
  • Low costs: Many mutual funds have low expense ratios, and most large brokers offer a list of no-transaction-fee funds with zero trading costs.
  • Dividend reinvestment: Dividends can be reinvested automatically, so you can enjoy the benefits of compounding.

Cons

  • High expense ratios: Expense ratios can be as high as 1% or more of your investment each year, significantly eroding your returns over time. 
  • Sales loads: Front-end and back-end sales loads (fees you pay when you buy and sell mutual fund shares) can be as much as 8.5% of the amount you invest, putting you in the red from the get-go. 
  • High investment minimums: Many mutual funds require an initial investment of $500 to $5,000 or more, making them impractical for smaller investors. 
  • Taxable events: If the fund realizes a gain from selling assets, you could owe capital gains taxes even if you haven't sold your shares.
  • Trades once per day: Unlike stocks, mutual funds trade once daily after the markets close at 4 p.m. Eastern Time.

Pros and cons of stocks

Stocks can offer larger potential returns than mutual funds and are easier to trade, but there are risks and drawbacks to consider.

Pros

  • Large potential gains: Stocks can have higher potential returns than other types of investments.
  • Dividends: Some stocks pay dividends, which can provide extra income and mitigate losses from falling share prices.
  • Easy to trade: You buy and sell stocks throughout the trading session via an online broker, such as TradeStation.
  • Low costs: Most large brokers (and many small ones) offer zero-commission trading for online stock trades.
  • Tax-efficient: Unlike mutual funds, you control when you pay capital gains by choosing when to buy and sell.

Cons

  • Large potential losses: Higher potential rewards come with higher potential losses if share prices drop and don't recover.
  • Low diversification: Individual stocks lack diversification, and many advisors believe you would need to invest in at least 20 to 30 stocks to diversify your portfolio adequately.
  • Higher risk: Betting on a single company introduces more risk than investing in a basket of assets, such as exchange-traded funds (ETFs) and mutual funds.
  • Time-consuming: It's your responsibility to research companies, pick stocks, and manage your portfolio—unless you work with a financial advisor like someone you find through WiserAdvisor or a robo-advisor, such as M1 Finance.
  • Stressful: Investors with a lower risk tolerance may find it difficult to sleep at night when the stock market is volatile or declines. 

Why would you invest in a mutual fund over a stock?

The mutual fund versus stock debate generally boils down to your personal goals and risk tolerance. Mutual funds are an excellent option if you want an easy way to diversify your holdings (i.e., set-it-and-forget-it) or don't have the time, interest, or expertise to research companies, pick individual stocks, and manage your portfolio. Mutual funds are also a smart choice for investors who want to avoid the emotional rollercoaster, stress, and sleepless nights that can accompany stock investing. 

Of course, you might also consider ETFs vs. mutual funds. Both are investment funds offering built-in diversification. However, unlike mutual funds, ETFs trade like stocks during regular market hours and may subject you to fewer taxes.

Why would you invest in a stock over a mutual fund?

Stocks offer larger potential returns than mutual funds, but the trade-off is increased risk. Stocks can be a smart investment if you have a higher risk tolerance, want control over your trading decisions, and are comfortable conducting your own fundamental research or technical analysis to pick investments. Stocks are also ideal if you prefer to minimize your trading costs and fees or want to control the timing of any capital gains.  

TIME Stamp: The best of both worlds

Stocks offer investors the greatest growth potential, often providing strong, positive returns over the long haul. WiserAdvisor, for example, puts the upper limit at 60 stocks, not 30. That diversification (i.e., not putting all your eggs into one basket) is the key to lowering risk and increasing the chances of earning more—even during periods of market volatility.

Still, researching, picking, and monitoring 20 to 60 stocks takes considerable time and expertise—something not all investors have. Mutual funds might be a more practical investment choice if you prefer a hands-off approach or want someone else making the decisions. Mutual funds offer exposure to stocks (and bonds and other securities) with the convenience of built-in diversification, but without the time-consuming research.

Of course, remember that you don't have to choose between stocks and mutual funds. Both can be part of a well-diversified investment portfolio that helps you grow wealth, save for retirement, and meet your long-term financial goals.

Frequently asked questions (FAQs)

Are mutual funds safe?

All investments carry some degree of risk and can lose value if the overall market declines or, in the case of individual stocks, the company folds. Still, mutual funds are generally considered safer than stocks because they are inherently diversified, which helps mitigate the risk and volatility in your portfolio.

Keep in mind that, like stocks, there are varying degrees of risk within the mutual fund universe. For example, short-term bond funds are generally safer and more stable than small-cap and credit-risk funds. So, if you decide to buy mutual funds, you can focus on ones matching your risk tolerance and goals. 

Do mutual funds outperform the stock market?

While mutual funds can outperform the market occasionally, it isn't easy to achieve over the long run. A study of actively managed mutual funds by S&P Dow Jones Indices (a division of S&P Global) shows how large-cap funds performed versus the S&P 500 over the previous one, three, five, 10, and 15 years:

1 year3 years5 years10 years15 years
Underperformed
51.08%
74.27%
86.51%
91.41%
93.40%
Outperformed
48.92%
25.73%
13.49%
8.59%
6.60%

The study found that most actively managed mutual funds do worse than their benchmark index during most calendar years and over the long run. Notably, low-cost stock and bond index funds generally offer more predictable returns and lower costs than actively-managed funds.

Should I move my stocks to a mutual fund?

You might consider moving money invested in stocks to a mutual fund if you want the convenience and built-in diversification that a mutual fund offers or someone else to make the investment decisions. On the other hand, you might opt for stocks if you're comfortable with more risk in exchange for higher potential returns.

Of course, you're not limited to one investment. Many investors hold an assortment of stocks and mutual funds in their investment portfolios and retirement accounts as part of an overall plan to build wealth.

The information presented here is created independently from the TIME editorial staff. To learn more, see our About page.

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