The Pros and Cons of Stock Mutual Funds

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Stock mutual funds combine the rewards of investing in stocks with the ease of putting money into a diversified mutual fund. Whether you plan to buy into stock mutual funds or individual stocks, it's essential to become familiar with the basics of each investment vehicle and how they work.

Key Takeaways

  • Stock mutual funds combine the rewards of investing in stocks with the ease of putting money into a diversified mutual fund.
  • A stock fund is an investment company that invests primarily in individual stocks of publicly traded companies.
  • It's important to weigh each pro and con of investing in a stock mutual fund prior to making a decision to invest.

Stock Mutual Funds

A stock fund is an investment company that invests primarily in individual stocks of publicly traded companies. For example, if you invest in a fund that owns shares of GE, Microsoft, Proctor & Gamble, and Dell, then you have invested in 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 in Stock Mutual Funds

  • Diversification: Perhaps the most positive aspect of a stock fund is that you can invest in a single stock fund and have money invested in hundreds of individual stocks. This diversification will reduce "company-specific risk," which is the inherent risk of buying stock in only one company.
  • Professional Money Management: Investing in individual company 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: Investing regularly in a stock fund is simple. Some 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. In this plan, money is pulled directly from your bank account or paycheck and invested directly in the stock fund.

If you're considering having your money automatically go into an investment payment plan, be sure that you won't incur a penalty fee for discontinuing your distributions at any time.

The Cons of Investing in Stock Mutual Funds

  • Lack of Ownership: When you invest your money in a stock mutual fund, you are a participant in the fund, but you do not own any individual stocks within it. Investors who buy shares in one or more companies directly own stake in the company, whether it makes or loses money. If you prefer to own a piece of Amazon or Apple and have voting rights in the company, you will want to buy the stock.
  • Costs: There are management costs involved with investing in a mutual fund that are passed on to the investor. If you buy individual stocks, you'll pay to buy the stock, but you shouldn't pay another fee until you sell the stock. Like other types of mutual funds, stock funds can charge load fees. 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 percentage of assets.
  • Choice Overload: If you decide to invest in a stock mutual fund, you may find more stock funds to choose from than individual stocks trading on the New York Stock Exchange. Some investors may feel overwhelmed with all of the mutual fund choices and could have a hard time choosing one. Be prepared to spend time and resources sifting through the variety of stock funds available. Read the prospectus of any stock mutual funds in which you're thinking of investing.

You should be able to easily find a fee structure for any mutual fund in which you're choosing to invest. If you can't get a written rundown of fees you can expect, you may not want to invest your money in that fund.

Weighing the Pros and Cons of a Stock Fund

It's important to weigh each pro and con of investing in a stock mutual 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. As an investor, you owe it to your future self to have a comprehensive understanding of the pros and cons of stocks funds and how to avoid or minimize the disadvantages of them.