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.
Basics of Stocks and Bonds
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.
Exploring Stock Characteristics
Common stock and preferred stock are two forms of shares which are often purchased by investors. A share of common stock represents partial ownership of the company which issued it. As the number of shares an investor owns increases, the percentage of the company they "own" increases in turn. These shares also carry voting rights, allowing investors to help influence the direction of the company.
With preferred stock, investors forsake voting rights in exchange for guaranteed access to dividends and other privileges. Preferred stock is classified as a higher priority than common stock, meaning that preferred shareholders will receive dividend payments before common stock owners. For those holding common stock, a dividend is considered a "bonus" rather than a guarantee.
Researching Mutual Funds
Here’s how a mutual fund works. You invest in the fund, and the fund in turn uses your investment dollars to invest in numerous companies all categorized based on different investment objectives. For example, if you’re young and can withstand greater financial risk, you might want an investment that has the potential for fast growth. You discover 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.
On the other hand, mutual funds are more like granny. Mutual fund prices don’t move during the day. Instead, something called net asset value (NAV) is used to determine the 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.