Why More of Your Portfolio Should Be in Mutual Funds Instead of Individual Stocks

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When you begin your investment journey, you may be comparing the differences between mutual funds and individual stocks, and while it is entirely possible to make money investing in both, mutual fund investing is a safer bet for your investments.

Mutual funds allow you to pool your money with other investors to get instant diversification which protects your investments and by investing in these funds you leave the management of the fund to professionals to build wealth. Diversification spreads your money across hundreds of companies, rather than just a select few. With individual stocks, your money is not as well protected as it is only held by that one or a few companies. Essentially, all your eggs are in that basket, and as a stock investor, you need to constantly do your research to build a portfolio that can make you money. Experts agree that mutual funds are a great means of building wealth.

15% of current investors started in 2020, according to a Schwab survey — which translates to millions recently embarking on their financial journey. As you begin your journey, weigh the pros and cons and understand where your money is going. “It’s important to understand what you’re trying to achieve,” says Monica Jalifedirector at Withum Asset Management

Let’s talk about the differences and why you should put your money in mutual funds instead of stocks.

What is the difference between stocks and mutual funds?

“A stock represents fractional ownership in an operation,” explains Dan RajuCEO at tradition, a fintech platform that provides stock and options trading. “A mutual fund attracts money from many investors to invest in a combination of many stocks and bonds.”

When you only invest in stocks, you can certainly make money, but it’s just harder. You should be trying to get the same returns you would get with a mutual fund, but you need a lot more capital to do it. Mutual funds offer investors the opportunity to invest in a diverse selection of companies. Experts agree that once you’ve built a solid, well-diversified portfolio using investment vehicles such as mutual funds, you can put some money aside to invest in stocks, but no more than 5% of your investment portfolio should go to them. Remember, when the company loses money, so do you, because the value of your stock drops. Therefore, protecting yourself with diversification is a very important part of investing.

When you invest in mutual funds, you have fund managers making decisions within the fund, such as when to buy and sell, adds Jalife. Because there are so many investors pooling their money, the fund can buy in on a larger scale than an individual investor. Mutual funds protect your money in a market downturn and protect your investments immediately.

Here are the most common differences between mutual funds and stocks:

SharesMutual fundsdiversificationExtremely limited. Provides instant diversification.CostNo ongoing costs after purchase. Calculates a cost ratio for the life of the investment.RiskHighest because performance depends on individual companies. Provides protection through diversity.Liquidity Very easy to buy and sell during trading days. Can only buy or sell at the close of the market each trading day.Research requiredIntensive research. Requires insight into the performance of any business. Minimal, except for choosing the right mutual fund for your goals and monitoring your investments.Portfolio Adjustment Highest. You can choose the stocks you like best. Minimal, apart from choosing the fund. You have no control over what is in the fund.

Advantages and disadvantages of mutual funds

The biggest benefit of investing in mutual funds is that you get instant diversification that protects you from risk in the event of a market crash. Even if the overall market falls, every company within a mutual fund is unlikely to fall all at once, protecting your money.

And while mutual funds charge an annual expense ratio or fee, it’s usually a very small percentage of your total investments. These fees go to the management of the fund.

“If you’re not very well-known or don’t have the time or inclination to think about which stocks to buy, a mutual fund might be a better route,” says Jalife.

Pro tip

A low-cost mutual fund that tracks a broad index is a reliable investment for most investors. Before investing, make sure you understand what’s in the fund and avoid high fees.

One thing to be aware of is that if the mutual fund is actively managed, there may be a high cost associated with that fund. For this reason, experts recommend a fund that passively tracks an index that tries to match the performance of the overall market, and that typically has low costs.

Advantages and disadvantages of individual stocks

The biggest selling point and benefit of buying individual stocks is the potential for excessive profits that exceed average market performance. It’s also the biggest drawback as there is also the potential for huge losses if the company underperforms.

For this reason, you’ll want to spend time researching the company’s financial history and future projections to make an informed decision about buying stock. Even if you do, having too much of your portfolio in a handful of companies doesn’t offer much diversification, especially if the companies are in the same industry, such as energy, materials, or real estate.

You are responsible for creating your own diversification, advises Jalife.

Are mutual funds better than individual stocks?

If you have the time and want to get involved, individual stocks may give you more control with a lower overall cost, but this is the risk. You need to understand the general principles of diversification and the risk your money is exposed to when you invest in stocks. If you don’t have the time or interest, a mutual fund is a better approach to have diversity with a team of professionals who manage it.

Raju adds that while there are thousands of individual stocks on the market, there are also many options available for mutual funds. So while it takes some research to find the right mutual fund for your investment goals and timeline, it’s usually more set-and-forget than selecting individual stocks, which requires ongoing research.

Mutual Funds vs ETFs vs Stocks

Mutual funds and ETFs are like cousins ​​with a lot in common. “Mutual funds only have prices at the end of the day,” explains Raju, while an ETF is a security that you can buy or sell in real time.

You can also buy and sell stocks in real time throughout the day, but a stock represents fractional ownership in a single company, while a mutual fund or ETF gives you fractional ownership of hundreds or even thousands of companies in a single trade.

You can think of individual stocks as the building blocks and mutual funds or ETFs as a big pool filled with those blocks. ETFs are a nice bridge between mutual funds and stocks because they have the diversity of a mutual fund with the liquidity of a stock.

Shares have no ongoing charges. You only pay fees or taxes when you buy, sell, or receive dividends. Mutual funds and ETFs have ongoing fees in the form of expense ratios that pay for the management of the fund. Stocks don’t have this fee because you manage them yourself.

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