Mutual Funds vs. Stocks: What’s the Difference? - NerdWallet (2024)

FAQs

What is the difference between a mutual fund and a stock? ›

Mutual funds diversify investments, reducing risk, but also limit potential gains. Stocks offer higher returns but come with higher risk and volatility. Explore key differences between Mutual funds and Stocks in this blog.

The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.

Another option is a low-cost S&P 500 mutual fund or ETF, both of which mirror the index and typically carry less risk than investing in individual stocks. An S&P 500 fund or ETF tries to replicate the performance of the index by investing in listed companies and working to match the index's performance.

Some of the advantages of mutual funds include advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing, while disadvantages include high expense ratios and sales charges, management abuses, tax inefficiency, and poor trade execution.

For many investors, it can make sense to use mutual funds for a long-term retirement portfolio, where diversification and reduced risk are important. For those hoping to capture value and potential growth, individual stocks offer a way to boost returns, as long as they can emotionally handle the ups and downs.

Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

In the category of market-linked securities, mutual funds are a relatively safe investment. There are risks involved but those can be ascertained by conducting proper due diligence.

Given how high the risk is with these mutual funds, it is best to limit yourself to a limited number of small cap mutual funds. Also, avoid putting in a great percentage of your total mutual fund investment in small cap mutual funds. Debt Funds: Ideally 1, but 2 is also good.

However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.

Are mutual funds safer than stocks? ›

All investments carry some degree of risk and can lose value if the overall market declines or, in the case of individual stocks, the company folds. Still, mutual funds are generally considered safer than stocks because they are inherently diversified, which helps mitigate the risk and volatility in your portfolio.

Key Takeaways. Many mutual funds are actively managed while most ETFs are passive investments that track the performance of a particular index. ETFs can be more tax-efficient than actively managed funds due to their lower turnover and fewer transactions that produce capital gains.

Potential Cons

Mutual funds have expenses, typically ranging between 0.50% to 1%, which pay for management and other costs to operate the fund. Some mutual funds have sales charges, or "loads," that investors pay when either buying or selling a mutual fund. Market risk.

To withdraw money from mutual funds, submit a redemption request to the fund house. The process involves filling out a redemption form, specifying the amount you wish to withdraw. Keep in mind that certain funds may have exit loads.

In the small-cap category, the top-performing mutual funds in terms of five-year returns as of now are Quant Small Cap Fund with a return of 40.66%, followed by Bank of India Small Cap Fund at 33.79%, and Nippon India Small Cap Fund at 32.03%.

A mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.

Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the whims of the market and thus offer a higher return potential than bonds, but they also present more risk.

Mutual funds are required to pass on all net income to shareholders in the form of dividend payments, including interest earned by debt securities like corporate and government bonds, Treasury bills, and Treasury notes. A bond typically pays a fixed interest rate each year, called the coupon payment.

Mutual funds make money by charging investors a percentage of assets under management and may also charge a sales commission (load) upon fund purchase or redemption. Fund fees, called the expense ratio, can range from close to 0% to more than 2% depending on the fund's operating costs and investment style.