The Pros and Cons of Stock Mutual Funds

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What are the pros and cons of stock mutual funds and should you invest in them? Whether you plan to buy stock funds or you plan to buy individual stocks, you should become familiar with the basics and how they work.

Stock Mutual Funds

Simply put, a stock fund is a type of mutual fund that invests primarily in individual stocks of publicly-traded companies. For example, if you buy a fund that owns the shares of GE, Microsoft, Proctor & Gamble, and Dell, then you own a stock fund. Some stock mutual funds also hold bonds and cash but stock funds will typically allocate at least 80% of the portfolio assets to stocks.

The Pros of Investing

  • Diversification: The first advantage, and some would say the most important aspect, of a stock fund is that you can invest in a single stock fund and obtain instant access to hundreds of individual stocks. This diversification will reduce "company specific risk" (the risk that is inherent if you buy just one or a few stocks).
  • Professional Money Management: Investing in individual stocks not only takes resources, but a considerable amount of time. By contrast, stock fund managers and analysts wake up each morning dedicating their professional lives to researching and analyzing current and potential holdings for their stock fund.
  • Systematic Investing and Withdrawals: It's simple to invest regularly in a stock fund. Many mutual fund companies allow investors to invest as little as $50 per month directly into the stock fund without incurring a transaction charge. This is called a Systematic Investment Plan (SIP). Money can be pulled directly from a bank account and invested directly in the stock fund. On the other hand, money can be regularly withdrawn from a stock fund and be deposited into a bank account. There are generally no fees for this service.

The Cons of Investing

  • Lack of Ownership: Investors that prefer to buy individual stocks as opposed to a stock fund, often cite that they give up ownership rights in a stock fund. They are referring to the fact that if you buy a stock fund, you own the stock fund and not the individual stocks within the stock fund. If you prefer to own a piece of GE and have voting rights in the company (albeit, generally a very small stake), then buy the stock.
  • Costs: In the case of a stock fund, you will be paying for ongoing management of the stock fund. If you buy an individual stock, then you pay to buy the stock, but do not pay another fee until you sell the stock. Like other types of mutual funds, stock funds can charge fees called loads. These fees can be charged on every purchase or on the sale of the fund. Mutual funds also have ongoing fees that come out of the fund returns. These costs are expressed in the form of an expense ratio, which is a percent of assets.
  • Choice Overload: Sometimes too many choices can be a problem. If you decide to buy a stock fund, you will find, odd as it may sound, more stock funds to choose from than individual stocks trading on the New York Stock Exchange. Be prepared to spend time and resources in order to sift through the variety of stock funds and manage your portfolio.

Weighing the Pros and Cons of a Stock Fund

It's important to weigh each pro and con of owning a stock fund prior to making a decision to invest. In many cases, what one investor might see as a pro, another investor might see as a con (and vice versa). Most investors would benefit from understanding more about the pros and cons of stocks funds and how to avoid the pitfalls.