For anybody looking to get into the stock market, it’s certainly easier said than done. You are instantly overwhelmed, from the moment you even start looking at brokerage firms (Scottrade, Merill Lynch, Fidelity, eTrade…) right down to when you start looking at actual stocks to invest in. Quite frankly, there are just too many options out there. Perhaps finally as you decide to invest in a certain stock, someone comes along and reminds you that mutual funds can be an attractive investment option too. Gaa! Options overload! In this post, I’d like to break down some of the pros and cons of investing in mutual funds vs. stocks.

Check out these articles for a quick refresher on how stocks and mutual funds work.

Mutual funds:

Think of investing in a mutual fund as putting your money into a basket full of stocks. Although you might only own one ‘share’ of a mutual fund, that one share of a mutual fund is invested (fractionally) in a number of different stocks all that meet the mutual fund’s criteria. If you’re investing in a ‘mid cap’, your mutual fund will invest in mid-size companies that are deemed to be growing and doing well. One mutual fund that I’m invested in owns shares of: Telsa (electric cars), United Rentals (rents out equipment), Kansas City Southern (railroad) and Towers Watson (professional services), to name a few. The lure of a mutual fund is that your money is being invested by a professional and that in theory; they should be able to pick better stocks than you.

Pros:

‘Expert’ Management. People running mutual funds are smart, certified and trained individuals. As to whether or not they can truly pick stocks better than you, that’s up to you to decide.

Easy to compare. Although you’ll still have to make a decision on how to invest your money, mutual funds can often be stacked side by side and compared. You can view their: top stock holding, Year to Date as well as historical performance (how much they were able to grow your money) and expenses/fees.

Cons:

Fees, fees, fees. Unlike with stocks, you are paying someone to actively manage your investments. This could range from 0.5% to 1.5% of your assets which means that they are taking 0.5% of your money as their fee to manage it. Therefore, your annual return is more accurately reflected by subtracting the expense fees.

Your return might just be ‘average’. With a bundle of stocks; some doing really well, some so-so and some not so good, you might start to see your returns sort-of average out. Although this number might still be 5% or so (depends on the fund’s returns), perhaps you could have done better putting all your money in a winner.

Stocks:

When you invest in stocks, you are solely buying an ownership share in ONE company. If I buy one share of Coca-Cola, I’ll be a 1/a very large number owner of the company. You’re putting more of your eggs in fewer baskets when you invest in stock. $100 of mutual funds might be invested in 20 different companies. The idea with mutual funds is that some of the stocks will do really well, some just so-so and some will lose money, but that you’ll end up on top when you compare all your holdings. With stocks, your gain/loss will come from that one stock. Unless it’s truly a winner, mutual funds might be a better option. However, if you fancy yourself a winning stock picker, picking a stock might be better. Picking one good stock could yield a better return than a bundle of them.

Pros:

No fees. Unlike mutual funds, the only expense you’ll see is the transaction fee when you buy/sell the stock (should be around $7 per transaction).

If you good at picking, you could make a lot more. In theory, if you only picked ‘winner’ stocks, you could earn a whole lot more than a more ‘across the board’ mutual fund. Of course, people running mutual funds are probably trying to do the same thing.

Cons:

Picking stocks isn’t exactly the easiest thing to do. Although picking stocks just takes a little research and a good head on your shoulders, it’s still pretty tough.

All in all, I’d actually recommend the average investor like you and me to put more of our money in mutual funds. I did a comparison last year and found that my stock picks returned me about 6% while my mutual funds returned me close to 20%. Those results are hard to argue with. For those of you looking to get into investing, I’d say start with mutual funds, and as you get better and more confident in your abilities, jump into stocks. The market is a crazy animal so by letting a professional investor invests your money in a mutual fund, you’d probably be playing things a little safer with your money!

Thanks so much for reading! Here’s another that might be helpful:

Talking about the ‘I’ word (investing)