Let’s face it, everyone from uncle Ernie to the cute sales guy at work talks about investing. The problem is, you’re not sure what the difference is between a stock and a mutual fund, let alone why you should invest in either. In a nutshell, mutual funds offer multiple options kind of like dating, whereas with stocks you settle down and pick the one that’s right for you.
At the most basic level, a share of stock represents partial ownership in a company. Whether you own one share or 1 million shares, you have ownership rights in said company. On the other hand, when you buy shares of a mutual fund, you don’t invest in the mutual fund company itself but in the fund’s portfolio of investments.
Stock comes in many forms, common, preferred, Class A, Class B and the list goes on. The most frequently bought is Class A common stock. It’s the kind you have available through your company’s employee stock option plan (ESOP) and typically the kind you buy through your discount brokerage firm. Preferred stock usually gets reserved for company officers but can also get purchased through brokerage firms. They each have benefits and drawbacks. Common stock holders can receive dividends, whereas preferred stock holders normally don’t. But if the company goes belly up, preferred stock holders get paid first. Either way, stock represents ownership in a specific company that you purchase in precise quantities at specific prices.
Here’s how a mutual fund works. You invest in the fund, the fund in turn uses your investment dollars to invest in numerous companies all categorized based on different investment objectives. For example, because you’re young and can withstand greater financial risk, you might want an investment that has the potential for fast growth. Just so happens there’s a mutual fund that invests in high-tech companies with great immediate growth potential. When you invest in this fund, you don’t buy individual shares of each company in the fund’s portfolio, you only buy shares of the fund. The fund spreads its investment dollars (including yours) across the individual companies. So when you buy one share of the mutual fund, that share’s performance depends on the performance of all of the fund’s underlying stocks.
Where’s the Money
If you watch a stock ticker for any extended period, you’ll notice that stock prices often fluctuate. Stock prices fluctuate with supply and demand for the stock. One minute, a company can trade for $15.25 per share and the next minute it can trade for $6.50 per share. Stock trading is live action from opening bell to closing bell. Just like a good MMA fight. On the other hand, mutual funds are more like granny. Mutual fund prices don’t move during the day; they use something called net asset value (NAV) to determine their share price. NAV equals the sum of the value of the mutual fund’s stocks, bonds, cash and other securities minus the managers’ salaries and other expenses. Divide that total by the fund’s total number of shares and that equals the net asset value. So unlike stocks, where prices can fluctuate during the day, mutual fund prices only get calculated at the end of the business day.
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