Individual stocks and mutual funds both get the same jobs done. If you need to save for a down payment on a home, Junior's college education, a brand new BMW for Missy's Sweet Sixteen or your retirement, either investment can help provide a savings boost. While they take similar paths to help you reach your goals, stocks and mutual funds are distinct products, requiring thoughtful consideration on several counts.
When you own individual stock, you hold an ownership stake in a company. This gives you the right to vote to elect the firm's board of directors. When you sell a stock, you incur either a capital gain or loss. You must report all capital gains to the IRS for tax purposes. You can use capital losses to offset capital gains, up to $3,000 a year, as of November 2010, according to the IRS. If a stock you own pays a dividend -- a share of the company's profits -- you must also claim this income on your tax return. While a mutual fund can hold stocks, this is not always the case. Mutual funds often hold another type of investment, such as bonds, currencies or commodities, or a combination of several kinds of investments. When you sell shares of a mutual, the same capital gains and losses rules apply. If the fund receives a capital gain on a trade it made within its portfolio, it distributes a capital gain to its shareholders. If a fund owns a dividend-paying stock, it pays out a portion of it as a distribution to its shareholders. Both of these are taxable events.
When deciding whether to own individual stocks or mutual funds, consider the amount of time, investing experience and money you have at your disposal. If you lack time and investing experience, it might be a wise choice to leave the decisions up to mutual fund managers. If you prefer to, and are capable of, controlling the reigns, you can take greater control and hold individual stocks as at least part of your portfolio. In terms of money, you really don't need a whole lot to invest. Countless online brokerages and mutual fund companies let you get into both individual stocks and mutual funds for as little as $15 to $50 a month with low commission charges.
Generally, the only fees you really need to concern yourself with when trading individual stocks are commissions charged by brokerages to conduct the buy and sell transactions. While mutual funds sometimes trigger commission charges, they also carry with them other fees that stocks do not. For instance, all funds have an expense ratio of usually around 1 percent that helps pay the fund's overhead. Some funds charge sales loads and redemption fees, which go toward other costs associated with marketing and running a mutual fund. As the U.S. Securities and Exchange Commission notes, federal regulations cap sales loads at 8.5 percent and redemption fees at 2 percent, as of November 2010.
It might be a challenge, particularly for the uninitiated, to truly and competently diversify a portfolio comprised solely of individual stocks. A primary function of mutual funds is to do just that -- ensure diversification. For example, if you own a large company growth fund that invests in American companies, you'll probably have indirect stakes in firms such as Apple, McDonald's, IBM and any where from tens to hundreds of others. It's tough to duplicate this and monitor it all via a slate of individual stock holdings. For most investors, a mix of both products -- single stocks and mutual funds -- is the best bet.
- U.S. Securities and Exchange Commission: Mutual Fund Fees and Expenses
- U.S. Securities and Exchange Commission: Invest Wisely: Mutual Funds
- U.S. Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification and Rebalancing
- IRS: Topic 409 -- Capital Gains and Losses
- The Motley Fool: What Should I Invest In?
- Mutual Funds & Risks
- What Determines Whether the Price of a Mutual Fund Goes Up?
- How Should I Allocate My Mutual Funds?
- Should I Keep Money in a Mutual Fund or Sell It?
- How to Avoid Front End Charges on Mutual Funds
- How to Adjust Your Basis When You Receive a Capital Gain Distribution on Your Mutual Fund
- Mutual Fund Liquidation Tips
- How to Claim a Capital Loss on My Mutual Fund
- Open Vs. Closed Mutual Funds
- How Quickly Will a Mutual Fund Multiply?