Mutual Funds vs. Stocks: Pros and Cons of Each Investment
Wondering if you should invest in mutual funds or stocks? The better question might be how much of your portfolio you should dedicate to each.
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Stocks might make up the bulk of a portfolio geared toward a long-term goal like retirement, particularly for younger investors with longer time horizons. But that doesn't mean you have to buy and trade individual stocks — you can also gain that exposure through mutual funds.
You can read more about the two investment types below, but we'll give a spoiler for those who don't want to dig into the details: Many investors will prefer the bulk of their portfolios to be mutual funds (specifically, index funds and exchange-traded funds, also known as ETFs). Once you're set there, you might choose to dedicate 5% or 10% of your portfolio to stock trading for a little thrill.
Mutual funds vs. stocks at a glance
Mutual funds | Stocks | |
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What they are | Shares of multiple companies in one investment. Active mutual funds are managed by a professional; index funds and ETFs typically track a benchmark. | Shares of a single company. |
Best for | Investors who want easy diversification and to invest in a large number of stocks through a single transaction. | Investors who want to build their own portfolio by picking and choosing specific companies. |
Fees |
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Learn about how to invest in mutual funds or how to invest in stocks. | ||
Stock mutual funds
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 simple investment portfolio might contain just a few mutual funds, which could be a combination of actively managed funds, index funds or ETFs.
We’re big fans of index funds and ETFs over actively managed mutual funds. Actively managed funds rarely beat the market, and they also come with higher fees to pay for professional management. These added costs can significantly eat into your returns over the long run. An index fund or ETF that tracks a benchmark like the S&P 500 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. That means 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. (Read more about robo-advisors and our picks for the top companies.)
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.
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.
Brokerage firms | |
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Individual stocks
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's 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 research stocks.) 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, you could compromise by setting aside a small portion of your funds for active stock trading, while investing the rest in a diversified portfolio of index funds or ETFs.
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.
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 may pay a commission to buy or sell.