It’s time to take all that cash you’ve been saving and put it to work. The problem is that there are so many investment options you can’t decide which is best. Two of the most common options are stocks and mutual funds. Understanding how each one works, as well as the risks associated with each, will help you decide whether mutual funds or stocks are best for you.
To better understand the differences between mutual funds and stocks, you need to know what each one is. You own stock when you purchase shares of a publicly-traded company. The object is to buy shares when they are low and sell them when they are high, profiting the difference. For instance, you invest $10,000 to purchase 100 shares of Company A stock, valued at $100 each. In a couple weeks, the price of each share increases $10 and you sell off all 100 shares at $110 each. You make back your original $10,000 investment plus $1,000. In a mutual fund, your money is pooled together with other investors’ by your investment firm and then invested in stocks, bonds and other securities. Each investor owns a certain number of shares in the mutual fund, which are redeemable at any time. The value of each share will increase or decrease depending on the performance of the various securities.
Both stocks and mutual funds pose a risk, but you might worry a little less when you invest in a mutual fund. With mutual funds, your money is spread around and invested in different types of securities. If one is performing poorly, that doesn’t mean the value of each share goes down because the other securities might be performing very well. Stocks don’t offer that same diversity. Your return depends solely on the company’s stock that you invested in.
Other Money Matters
You should count the cost of your investment before you decide between a mutual fund or stocks. You usually have to pay one-time brokerage fees for stock market transactions but the fees associated with mutual funds may cut a little deeper into your earnings. The fees will depend on the brokerage firm but often there are brokerage and management fees as well as transaction fees for purchases, redemptions and exchanges. Fees vary depending on the firm so read the fine print to make sure you know exactly what you’re paying for.
Going it Alone
Mutual funds are ideal for new investors or for anyone who isn’t familiar with the stock market because you are essentially turning your money over to an investment professional, who is trained to make wise investment decisions for his clients. Success in the stock market requires continuous research and study to reduce your chances of losing money. On the other hand, the stock market allows you to have more control over your investments but when you lose money, there is no one to blame but yourself.
The Bottom Line
You could split up your money and invest in both, but mutual funds are comprised primarily of stocks, so by investing in mutual funds, you are essentially investing in stocks as well. Mutual funds also offer the benefit of portfolio diversification, because they consist of various stocks and other securities. The more diverse your investment portfolio is, the less likely you are to lose huge sums of money. The diversity and security attributed to mutual funds makes them a much better investment option for many beginning investors.
Based in South Florida, Leann Harms has been writing since 2008. Her design, technology, business and entertainment articles have appeared in "Design Trade" magazine and Web sites including eHow. Harms has a Bachelor of Arts in English from Florida Atlantic University.