Should You Invest in Mutual Funds or Stocks?

couple deciding on finances
With mutual funds, you don't have to spend time researching individual stocks. Photo: Steve Prezant/Getty Images

Whether you invest in mutual funds or stocks depends on how much risk vs. return you are prepared to handle. If you want a higher return, then you must accept a higher risk. It also depends on how much time you have to learn about individual companies, which is necessary before buying that company's stock, vs. the smaller amount of time needed to learn about mutual funds.

Stocks vs. Mutual Funds

Stocks are riskier than mutual funds.

Funds pool a lot of stocks (in a stock fund) or bonds (in a bond fund). That reduces risk because, if one company in the fund has a poor manager, a losing strategy, or even just bad luck, its loss is balanced by other businesses that perform well. Mutual funds don't require as much time to research because the mutual fund manager does that for you.

On the other hand, it takes time to research the mutual funds. That has its own set of challenges. The managers are always changing the companies they own, so you don't know what you are getting. You can look at past performance, but if a manager changes the performance can change dramatically. Besides, mutual funds charge annual management fees, while stocks only cost the initial outlay. 

Risk Return Tradeoff

By pooling a lot of stocks (in a stock fund) or bonds (in a bond fund), mutual funds reduce the risk of investing. If one company in that sector has a bad manager, or a losing strategy, it is balanced by other companies that are performing better.

This lowers the risk, thanks to diversification. For example, an financial services fund in 2008 that included Lehman Bros. stock would have declined with Lehman's demise, but not nearly as much as those who only had Lehman stock...they would have lost their entire investment. For more, see What's the Difference Between Bonds and Bond Funds?

Time Available to Learn About Stocks vs. Mutual Funds

To learn about investing in stocks, you need to research which company is the best investment. To do company research, you need to learn how to read financial reports to see how much money the company is making, and what strategies it is using to grow earnings. You must stay apprised of how the economy is doing, and how that will affect that company and its industry. You will want to pick companies who are in industries or sectors that are on the upswing.

To pick mutual funds, you don't need to learn how each company is doing - that is what the mutual fund manager does. However, you still need to research the past performance of the mutual funds. You also need to decide which sectors seem most promising. Of course, you still need to know how the economy is doing.

Mutual Funds FAQ