Lately I’ve been hearing a lot of mutual fund investments and how they are the new “in” thing to grow one’s money. If you google it, you’d see a lot of comparisons between the two. You can go deeper, but for now, I’d give you a very brief overview of the bottom lines.
Before the overview though, an equally brief background – stocks are shares of a company (see this article for the details), while mutual funds would be a mix of investments (stocks, bonds, etc). Mutual funds are usually a mix of investments decided by the investment company you buy it from.
In the world of finance, one phrase you’ll always hear is that the higher the risk, the higher the returns.
With mutual funds, your risk is minimized. They mix and match, and some of these have lower risks, and therefore, lower returns. For example, let us compare putting $1,000 in XXX Company’s stocks against a mutual fund. The mutual fund, for example, includes $300 in XXX Company’s stocks, $500 in Treasury Bonds and $200 in ABC bonds. Suppose XXX Company’s stocks doubles in value. If you are investing in stocks, you earn $1,000. If you invest in mutual funds, you earn $300. Suppose now that XXX Company’s stocks drops to nil. If you are investing in stocks, you lost $1,000. If you are investing in mutual funds, you only lose $300. You should know though that the investment company decides on the portfolio.
Maybe you’ll now ask, so maybe you’ll just diversify it on your own, in which case we go to item number 2:
2. Transaction costs
Taxes, transaction costs and commissions should be taken into consideration. It will be impractical to buy $100 stocks and pay $10 transaction costs. Hence, these should be considered when investing. The SEC even has a guide for these.
Mutual funds, in a way, are but a diversified portfolio that is well calculated. Unfortunately, you will be paying for these calculations. It is like having a middleman that takes a cut off your profits. You’ll have to take this in mind when deciding.
However, having a middleman does make things easier. You don’t have to worry about the documentation, applications whatsoever. The middleman will handle it for you.
There are other things to consider – like the fact that you can vote using stocks and not with mutual funds – but these two are the main considerations. I do think, however, that if you are really into investing, then stocks the choice for you. But if you just want an egg nest that pays better than the bank (with more risk though), then mutual funds it is – as evidenced by how often it is used for retirement plans. Either way, they are both great ways to grow your money and be a step closer to financial independence.