If you’re new to investing, here’s what you need to know about mutual funds and stocks.
Updated
7 min. read
You’re ready to become an investor, and that’s a good thing. Investing helps build a sustainable future while offering an invaluable cushion to withstand financial bumps on the road ahead. To ensure you’re not jumping headfirst into the seeming unknown, you’ve decided to wade into the investment waters slowly. But the question that keeps you up at night is: should your first step be stocks or mutual funds?
Both can prove beneficial to your financial security. But it’s important to understand the distinctions between mutual funds and stocks before selecting one approach over the other. As we’ll soon see, various factors – including one’s goals and relationship to risk – should be assessed by every new investor to help determine the right choice.
First, let’s better understand those choices.
What is a mutual fund?
When you pool your money with other investors to "mutually" buy stocks, bonds and/or other investments, you’ve invested in a mutual fund. When investors buy shares in the fund, the mutual fund company pools that money to make investments on their behalf. As with stocks, a mutual fund investment implies that you own a share of the company in which you’re investing, though the piece of your pie is a lot smaller than with the former investment.
Since mutual funds are facilitated by money managers, the decision as to which securities (stocks, bonds, etc.) to buy and when to sell is determined wholly by those professionals. If a mutual fund is the route you want to pursue, meeting with an investment advisor is a necessary first step. An advisor is legally required to have your best interest at heart, a fact that should help quell any concerns, though ongoing management fees are to be expected.
What is a stock?
When companies want to raise capital to fund their business, they sell shares of stock. Effectively, they’re inviting investors to purchase an ownership interest in the company, making them part owners. When you buy a stock, the small portion that you own is called a share. Investors can buy and sell individual stocks on the stock exchanges – specifically, the Nasdaq and New York Stock Exchange (NYSE) in the U.S., and the Toronto Stock Exchange (TSE) in Canada.
Pros and cons of mutual funds
Stocks and mutual funds have their advantages and disadvantages for both early and long-time investors. It’s important to view the pros and cons side-by-side so that you better understand the distinctions and feel confident that you’re making the choice that works for you. Let’s look at the benefits of mutual funds first.
Diversification
Since mutual funds involve the investment in various stocks and bonds, they offer investors the important opportunity to diversify their portfolio. Diversification ensures that you don’t put all your eggs in one basket. It’s essential to minimizing risk and reducing the impact you’ll experience if one (or more) individual stock fluctuates in price.
Low cost
Typically one must pay transaction fees for every stock you hold. By investing in mutual funds, an investor can more affordably invest in those same (or other) stocks since they’re pooled together. But remember that there will be ongoing management costs that must be paid to your advisor for their efforts, while an investment in stocks will only require the initial investment cost.
Convenience
When you invest in mutual funds, you’re working with experienced professionals who conduct a lot of research before establishing fund strategies and making trades or other decisions. You have little work to do on your own, which can alleviate much of the stress for new or busy investors. It’s probably why mutual funds are considered more beginner-friendly than investing in individual stocks.
Of course, that also means you have no choice but to go through an investment advisor, even if you prefer to work on your own. That’s why experienced investors sometimes prefer not to invest in mutual funds, opting for investments that are more customizable to their preferences.
What other potential downsides are associated with mutual funds? Since even the best portfolio manager can’t predict the performance of a fund, there is the potential for a loss of principal on the investment.
“Investing helps build a sustainable future while offering an invaluable cushion to withstand financial bumps on the road ahead. ”
Now let’s look at the benefits and disadvantages of investing in stocks. When you invest in stocks, you put more of your money in one place. That reality typically translates to higher potential returns than do mutual funds. It can also mean, however, a greater risk because you are now more impacted by the up-and-down fluctuations that come naturally to stocks. As a result, investing in stocks requires each investor conduct extensive research on the companies before investing in them. Some stocks pay dividendswhich can prove especially helpful in the face of falling share prices. Unlike mutual funds, you control when you pay capital gains by choosing when to buy and sell. Generally speaking, for those just starting their investment journey, mutual funds can prove the more agreeable choice. More advanced investors who prefer to customize how, and when, they invest their money, may find that stocks fit their needs more profoundly. But how you invest is a big decision and ultimately depends on your personal needs and preferences. Some factors to consider before choosing one investment approach over the other include: Do you want an option that allows you to set-it-and-forget-it? If you’re already struggling to keep up with your to-dos each day, adding another research-heavy task to your list may feel especially difficult. Investing in a mutual fund offers an opportunity to work with a professional investment advisor whose expertise and multifaceted support are appreciated and welcomed among new and experienced investors alike. To be fair, the know-how that professional advisors bring to the table could help anyone who feels that investing is not their forte. Mutual funds are also the best bet for investors who want to avoid the high stress and sleepless nights that often accompany stock investing. If, however, you have a strong interest in, and knowledge of, investing as well as the requisite time to dedicate to researching companies, picking stocks and managing your portfolio, stocks may be the best option for you. The other factor to consider is your time horizon. Typically, mutual funds are most suitable for longer-term investors. If you believe you’ll need your money in liquid form within the next few years, a mutual fund may not the best choice. Because any return you’ll make in that short period of time – after subtracting the fees - may undermine the value of the investment itself. Finally, you need to gauge your risk tolerance. As we’ve seen above, if you’re comfortable with taking risks, investing in stocks may suit you just fine. If you weigh more heavily toward risk aversion, well, mutual funds can be the answer you’re searching for. Taking each of those factors into consideration, ask yourself these questions before investing in either choice: The following chart may help illustrate the distinctions: How you invest your money is one of the most important decisions you’ll make. If you’re still unsure of which option is best for you, you can speak to one of BMO’s Investment Professionals across the country. Whichever direction you choose to invest your money, be sure to consider all the factors carefully. It’s about making your money work best for you, after all. To learn more about investing check out BMO’s Investment Learning Centre.Pros and cons of stocks
Higher returns
Dividends
Tax-efficient
Which is a better investment option for you?
Hands off or on
Short or long-term
To risk or not to
Mutual Funds Individual Stocks Diversified Less Diversified Lower Risk Higher Risk Ongoing Management Fees One-Time Fee Beginner Friendly Not Beginner Friendly Requires Little to no Research Requires Market Research Less Customizable Customizable Key takeaways
