Why You Should Invest in Mutual Funds vs. Individual Stocks Why gamble on your financial future when you can make a sure bet every time?
By Kyle Leighton Edited by Kara McIntyre
Opinions expressed by Entrepreneur contributors are their own.
Investing in financial markets is an effective means of building wealth and securing a comfortable future. With the right portfolio (and a bit of market savvy), investors can increase their asset value, strengthen their positioning and build a sizable nest egg. With a well though out investing strategy and some careful planning, your personal financial goals can not only be achieved, but often times on a timetable that suits your needs.
Investing comes with risks; however, everything from inflation to geopolitical instability can cause wild swings. Nonetheless, even in volatile markets, there are few other opportunities that can equate to the magic of compounding interest. Here's how mutual funds can minimize your personal investment risk with the right asset selection.
Understand the difference between mutual funds and equities
Equities, or stocks, are securities that grant limited ownership rights of a company to the buyer. Some pay dividends, award voting power, or simply offer profit potential when they appreciate. These types of investments would favorable to an investor that is actively managing their investment portfolio, and that understands how trading works.
By contrast, mutual funds are "basket" investments, where investors pool assets to purchase stocks, bonds or other securities. A single share of a mutual fund may contain slices of dozens or hundreds of individual assets. Some focus on specific goals, such as sector or growth investing, while others passively track indexes.
For experienced investors who can afford the risk, individual stock picking provides a chance to "get lucky". But most investors will fare better by pouring their capital into funds rather than taking unnecessary risks.
Related: The No. 1 Easiest Way to Lose Money in the Stock Market
Funds boast automatic diversification
Experts agree that diversification is crucial to long-term investing strategies. By spreading capital and risk across multiple sectors and securities, it's possible to safeguard your investments against market volatility. When choosing individuals stocks, this can be a bit tricky to do — especially in volatile markets.
As mutual funds hold a large number of securities, they offer automatic diversification. Each basket may be spread across sectors and market caps or include bonds or other securities to hedge against equity risk. Some securities may go up, while others may go down. When the value of a single or even handful of securities slides, diversification pads the impact.
Related: Top 5 Strategies to Get Started Investing While the Market Is Hot
Balancing fees and trading commissions
Mutual funds charge varying fees, depending on the type and objective of the fund. Active funds that trade frequently and keep an investment manager on hand may cost more than algorithm-based passive funds. But generally, mutual funds keep their costs under 1% of assets under management (AUM). For a new investor, or a passive investor, this is not only the easiest but likely the most cost-effective option.
Unlike mutual funds, stocks have no annual or ongoing fees to consider. Still, a single share may run hundreds or thousands of dollars, frontloading your purchasing expenses. Additionally, many brokers still charge commissions on trades, which mutual funds often swallow under their AUM fees. Depending on your own financial goals, you will need to consider the impact of fees of buying and selling individual stocks as they will impact your overrall return.
Factoring in time
Investing in individual stocks is an ambitious, time-consuming process that requires a lot of due diligence. Informed trading decisions rely on an investor's understanding of the economy, diversification and financial reports, as well as research into each company's history, management and fundamentals. With so many different pieces of information to consider, investing decisions can sometimes become confusing. Furthermore, things change and as a result, so might your investing strategy.
But mutual funds do the hard work for investors. While investors should understand the type, cost, historical returns, and general trading strategy of a fund, the managers or algorithm manage the actual trading (though they're not entirely hands-off, as it may become necessary to rebalance or modulate risk over time). For new investors, or investors interested in passive management, a mutual fund would be the best option when considering time.
Related: The Difference Between Direct Indexing and ETFs
Funds offer more convenience
One of the biggest perks that mutual funds offer over individual stocks is sheer convenience. Investors can still achieve strong market returns and reach their financial goals without having to invest the same amount of time as a financial expert or broker would. While a pure set-it-and-forget-it strategy is still unwise, monthly or even quarterly checkups, rather than full-time devotion, would be most than sufficient. In addition, they would be saving money on transaction and brokerage fees, normally incurred in individual stock investing, by opting for the convenience of a mutual fund.
So, though the last few years have seen a rise in retail trading — leading to one-off wins like that of GameStop — mutual funds offer a steadier, more reliable path to wealth generation. And when it comes to your financial future, why gamble when you can make a sure bet every time?
