Should You Invest in Stocks or Mutual Funds?

When you invest in a stock, you are purchasing a share of one company. A mutual fund offers more diversification by bundling many company stocks into one investment.

Arielle O'SheaOctober 27, 2020
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Stock should make up the bulk of most portfolios geared toward a long-term goal like retirement. But that doesn't mean you have to buy and trade individual stocks — you can also gain that exposure through equity mutual funds.

Mutual funds vs. stocks

What's the difference between stocks and mutual funds? Stocks are an investment in a single company, while mutual funds hold many investments — meaning potentially hundreds of stocks — in a single fund.

You can read more about each strategy below, but we'll give a spoiler for those who don't want to dig into the details: Many investors will prefer to form the bulk of their portfolios with mutual funds (specifically, low-cost index funds and exchange-traded funds, also known as ETFs, which we explain below). Once you're set there, you might choose dedicate 5% or 10% of your portfolio to stock trading for a little thrill.

ETFs vs. stocks: A quick breakdown

An ETF is a type of mutual fund with all the same benefits (think diversification and reduced risk), yet it has one major difference: It can be traded throughout the day just like individual stock. Moreover, much like index funds, passively managed ETFs often have very low expense ratios compared with actively managed mutual funds.

Investing in ETFs can deliver the benefits of mutual funds without the added cost of active management, while offering the liquidity you’d get from investing in individual stocks. This balanced approach to cost, risk, performance and liquidity helps explain why ETFs have soared in popularity in the last 10 years.

So what’s the catch? Like index funds, ETFs aren’t designed to beat the market. They’re designed to track it, meaning when the underlying index falls, so too will your ETF. To beat the market, you’ll need to invest in individual stocks or actively managed funds that will outperform in the future — a feat that usually requires diligent research and a bit of luck. But even aided by the best expertise, these investments rarely beat the market over the long term.

Learn more about ETFs to see if they might be a good fit for you.

Stock mutual funds

Pros

  • Easy diversification, as each fund owns small pieces of many investments.

  • Professional management available via actively managed funds.

  • Investors can typically avoid trade costs.

  • Many index funds and ETFs have low ongoing fees.

  • Convenient and less time-intensive for the investor.

Cons

  • Annual expense ratios.

  • Many funds have investment minimums of $1,000 or more.

  • Typically trade only once per day, after the market closes. However, ETFs trade on an exchange like stocks.

  • Can be less tax-efficient.

The details

Stock mutual funds (also known as equity mutual funds) are like a middleman between you and stocks: They pool investor money and invest it in a number of different companies. Rather than picking and choosing individual stocks yourself to build a portfolio, you can buy many stocks in a single transaction through a mutual fund.

That makes mutual funds ideal for investors who don’t want to spend a lot of time researching and managing a portfolio of individual stocks — a mutual fund does that work for you. A simple investment portfolio might contain just a few mutual funds, which could be a combination of actively managed funds, index funds or ETFs.

» Need guidance? Check out these model mutual fund portfolios

We’re big fans of index funds and ETFs over actively managed mutual funds, and not only because actively managed funds rarely beat the market. They also come with higher fees to pay for professional management of your funds, and these added costs can significantly eat into your returns over the long run. Tracking a benchmark with an index fund or ETF provides an excellent shot at strong long-term investment returns, along with diversification and lower fees.

Keep in mind that mutual funds aren't totally hands-off: You still have to stay on top of your portfolio — you may want to rebalance periodically, check fees, and ensure that you're still invested at the appropriate level of risk.

If you don't want to do that, you might be a good candidate for a robo-advisor, an online portfolio management service that invests for its clients and automatically rebalances portfolios as needed. These companies generally invest in ETFs. (Here's more about robo-advisors, what they do, and our picks for the top companies.)

» Want more options? See our picks for the best brokers for funds.

Individual stocks

Pros

  • Highly liquid.

  • No annual or ongoing fees.

  • Complete control over the companies you choose to invest in.

  • Tax-efficient, as you can control capital gains by timing when you buy or sell.

Cons

  • Carry more risk than mutual funds.

  • Must hold many individual stocks to adequately diversify.

  • Time-intensive, as investors must research and follow each individual stock in their portfolio.

  • You'll generally pay a commission to buy or sell.

» Ready to start? See our rankings of the best online stock brokers

the details

Could you do much of the work of a mutual fund, index fund or ETF yourself, by buying stocks outright? Sure, if you want to quit your job and start day trading.

Jokes aside, it is an ambitious and time-consuming undertaking to build a portfolio out of individual stocks. Each stock requires research; you'll want to dig into the company you're considering investing in, as well as its management, industry, financials and quarterly reports. (Here's more on how to do that research.) You then need to put a number of these individual stocks together into a portfolio that manages risk by diversifying across industries, company size and geographic region.

Still, some investors like the thrill of that chase. Should investing be thrilling? Boring is probably better. But if you get a rush from attempting to pick a winner, how about a compromise: Set aside a small portion of your funds for active stock trading (and brush up on our how-to guide), while investing the rest in a diversified portfolio of index funds or ETFs.

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