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 into 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: We highly recommend that most investors form the bulk of their portfolio with mutual funds (specifically, low-cost index funds and exchange-traded funds, also known as ETFs). Once you’re set there, feel free to dedicate 5% or 10% of your portfolio to stock trading for a little thrill.
What is it?
|A share in one company's profits.||A portfolio of investments. Active mutual funds are managed by a professional; index funds and ETFs typically track a benchmark.|
|You want to build your own portfolio by picking and choosing to invest in specific companies.||You're after quick, easy diversification and want to invest in a large number of stocks through a single transaction.|
|Trade commissions when bought or sold.||
|More about individual stocks||More about mutual funds|
» Don’t have an investment account? Here’s how to open one
- 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.
Equity mutual funds are like a middle man 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 as few as two mutual funds.
» Need guidance? Check out these model mutual fund portfolios
But key to the mutual fund argument is that there are several types of mutual funds: Actively managed funds, which are helmed by a professional manager; index funds, which track a benchmark index like the Standard & Poor’s 500; and ETFs, which are a category of index funds — they typically track an index, but are traded throughout the day like stocks.
We’re big fans of index funds and ETFs over actively managed mutual funds, and here’s why: While the professional managers behind active funds aim to beat the market, they rarely do, especially once you adjust for fees. And as you can imagine, a fund that employs a professional manager comes with higher fees. 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, online portfolio management services that invest for their clients and automatically rebalance 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.)
- 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’ll generally pay a commission to buy or sell.
» Ready to start? See our rankings of the best online stock brokers
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.
» Learn more: How to invest in stocks