Stocks represent ownership shares in individual companies. If you buy 100 shares of Facebook stock, for example, you actually own a very small percentage of the company, and are entitled to a commensurate share in the company’s profits. A stock mutual fund, in its most basic form, is a collection of individual stocks. If you buy 100 shares of a stock mutual fund, you might have partial ownership in hundreds of different companies.
Beyond the basics, however, stocks and mutual funds have very different characteristics; to better decide if one or both might be right for your investment strategy, learn the characteristics of each. Here’s a look at how to invest in mutual funds and stocks.
Investing in Individual Stocks
Stocks are available for the general public to purchase on exchanges, such as the New York Stock Exchange. On any given day, investors might trade tens of millions of shares or more of popular stocks like Apple (AAPL). The prices you see scrolling past on financial news networks are the dollar amount you must pay to buy one share of stock. Once you own a stock, you can expect the price to fluctuate from minute to minute, or even faster. If you choose to sell your stock, the difference between the price you paid and the price you receive is your capital gain or loss.
Investing in Mutual Funds
Mutual fund pricing is glacial in nature compared to the whiz-bang world of stock trading, as most mutual funds are only priced once per day, after the close of the market. At this point, the fund company tallies up the value of all of its underlying stocks and divides that amount by the number of outstanding shares to arrive at a price per share. As with individual stocks, when you sell your fund shares you’ll generate either a gain or a loss based on the original purchase price of your shares, minus any fees associated with the fund.
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Stocks vs. Mutual Funds
When you buy an individual stock, you’re the manager of your own portfolio. You make all the investment decisions regarding when to buy or sell your shares, and you’ll be the one responsible for determining a company’s investment potential through your own research. With a mutual fund, you are hiring a professional money manager to do that work for you. The fund company will decide which companies to buy or sell within the portfolio, and you’ll be a passenger along for the ride.
Fees & Costs
You’ll usually pay a stock commission whenever you buy or sell an individual stock. For online brokers, this cost can be $6.95 per share or even less. Mutual funds come in two flavors, load or no-load. Load funds can charge 5.75 percent or more in upfront fees; some funds instead charge a “contingent deferred sales charge,” which costs you money to sell instead. True no-load funds, such as many offered by low-cost pioneer Vanguard, charge you nothing to either buy or sell a fund. However, all funds do have ongoing costs delineated in an annual expense ratio.
Hybrid Investment Alternatives
Exchange-traded funds are mutual funds that trade on an exchange, just like a stock. You can buy or sell an ETF at any time that the stock market is open for trading, and you’ll pay traditional stock commissions. However, when you buy an ETF, you are buying a portfolio, just like with a mutual fund.
The main difference between traditional mutual funds and ETFs is that most ETFs are passively managed. Unlike more traditional actively managed funds, passively managed ETFs generally track popular stock market indices, such as the Standard & Poor’s 500 index. Rather than having a manager pick and choose which stocks to own, a passively managed index fund simply owns the stocks in the underlying index. As such, most ETFs have extremely low expense ratios; top mutual funds in the category may cost as little as 0.03 percent of your assets annually.
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The Portfolio Approach
A key concept of successful investing is to achieve the highest return possible with the lowest amount of risk. Taking a portfolio approach to your investments is often a sound strategy, as portfolio diversification aims to lower risk. You can diversify your account by owning a number of individual stocks combined with a selection of top mutual funds. But bear in mind that you can only attain the benefits of diversification if you select investments that do not move in lock-step with one another. For example, adding an S&P 500 index fund to a portfolio of the top 10 stocks in the index will not provide much in the way of diversification.