November 7, 2019

Mutual Funds vs Stocks - A Detailed Comparison

Stocks and Mutual Funds are two of the most favorite options of 'return starved' investors.

They're the most potent wealth creating tools available today in the market and the most preferred among investors of all categories - from the first-timers to the advanced users.

If the stock is a doting grandfather who showers his children (the investors) with gifts (returns), then the mutual fund is the kids’ favorite uncle who spoils them with choices.

The Origin

The concept of stock trading came-up somewhere in the 1500s, but the first publically trading in a company started in 1602 when the Dutch East India Company released its stocks on the Amsterdam Stock Exchange.

On the other hand, the birth of the mutual fund is associated with the financial crisis that happened in Europe in the early 1770s. The first mutual fund was started in 1774 when a Dutch merchant pooled money from subscribers and formed an investment trust.

What they Signify

Stock Investment

The term stock shows the ownership of investors in a company. Owing to the shares of a company gives the investors the name shareholder or stakeholder, and it fetches voting rights in their way.

The shareholder gets fractional ownership in the company and it also makes them eligible to get a part of the company's profit.

Depends upon their liquidity, stocks are classified into illiquid and liquid stocks. Stocks that have less volume, i.e., have less number of buyers as well as sellers, are called illiquid stocks. Stocks that trade frequently are called liquid socks.

Another major classification of share is common and preferred shares. Common shareholders enjoy voting rights while the preferred shareholders get preference in dividend payout, but they usually don't get the voting rights.

See - Tradingkart Stock Research Tool (Best Stock Ideas)

Mutual Funds

A mutual fund is an asset, managed by professionals, that collects money from different people and invests this pool of money in various financial instruments. The classification of these funds depends upon where they invest money. Four main categories that exist in the market today are money market funds, bond funds, stock funds, and target date funds. Depends upon the investment goal and risk appetite, the investors can select a mutual fund.

Money market funds invest in high credit quality and short-term maturity money market investments. These money market instruments are less risky as they are fixed income securities.

Bond funds are designed for those who look for higher returns. So they've comparatively high risk. These funds invest either in fixed income securities or in bonds. As there're various types of bonds available, the risk and reward of different bond funds vary broadly.

A stock fund or equity fund invests money in common stocks. Various types of stock funds available today are growth funds (invest in the stocks having higher potential growth), income funds (invests in the shares of those companies which give regular dividend), sector-specific funds (invest only in the shares of a particular sector), and index funds (invest in the stocks of index companies).

Target date funds invest in a mix of stocks, bonds, and convertible securities. The combination of these investments varies with the strategy of funds.

Mutual Funds vs Stock Comparison List

Basis	Stocks	Mutual Funds
Definition	The stocks represent the ownership of investors in a company.	A mutual fund is an asset that pools money from various investors and invests them in different financial instruments.
Risk	The risk level of stocks is very high. Investors have control over a few risks, while others are beyond their control. Economic risks, inflationary risks, and market value risks are beyond the control of the investors. However, the risk associated with a particular company or sector can be avoided by switching to another one.	Risk varies with the type of funds. It ranges from low to very high.
Management	The investor himself manages it.	Qualified professionals called fund managers, manage the funds.
Diversification	Diversification is possible only through investing in several companies from different sectors.	Diversification is possible even by investing in a single fund as the fund invests the money in several financial instruments.
Price	The demand and supply determine the price. The price moves up with the increase in the demand and moves-down with the rise in the supply. During the trading hours, the price moves up and down depends upon the demand and supply.	Price is determined by the Net Asset Value (NAV). NAV= (Asset-Liabilities)/ Total no. of outstanding units of the fund. NAV changes on every trading day.
Liquidity	Stocks are traded directly on the stock exchanges. So they have high liquidity. However, investors may find it difficult to liquefy thinly-traded stock.	A mutual fund offers a significant level of liquidity and flexibility. The investors can sell the shares back to the fund any time and will get the money within seven days.
Fees	Stocks are traded through a broker. On the execution of each trade, the investor needs to pay a sum to the broker called brokerage. The commission of a discount broker is much lower than that of a full broker. Nowadays, some brokers offer $0 commission trading.	The fund houses pass the cost associated with mutual funds to the investors in the form of expenses and fees. These costs vary from fund to fund. Usually, the funds with a higher return rate have more costs than that have a lower return.
Tax	If the sale of stocks happens after a holding period of 12 months, then the gains will be taxed as per the long term capital gains. It's 15% for the investors belong to the tax bracket of 22% and above, while only 5% for those in the tax bracket of 12% and lower. The short term capital gains are taxed at the regular income tax rates.	Mutual funds are taxed upon their category. Stocks funds are taxed on capital gains. Usually, the interest earned in bond funds is taxed as ordinary income. But, depends on the type of bond funds, sometimes the investor may need to pay some more taxes. Index funds fall under the lowest taxed category.
Returns	The historical average annual return of the stock market stood at 10%.	The return from mutual funds depends upon their category. The ten-year average return of large growth funds stood at about 12%, while that from asset allocation funds was slightly above 6% for the same period.
Minimum Investment	The investors can purchase as less as one unit.	The minimum investment varies from fund to fund.
Buy/Sell	In the primary market, investors can buy stocks directly from the issuer. While in the secondary market, they can buy/sell from/to other investors. Direct stock plans allow investors to buy/sell the stocks directly from the companies. But under this plan, the buy/sell happens at the set time on a particular date as per the policy.	Investors can either purchase directly from the fund houses or through a broker.
Trading	Stocks are traded during the market hours and their prices fluctuate continuously during the market hours.	Mutual funds trade only once in a day, usually, after the market closure. If the investor enters a trade, it’ll be executed at the next available NAV, which is calculated after the market hours.

See - Top Stock Market Terms Explained to learn Basic Concept of Stock Market

Mutual Funds vs Stock Pros and Cons

Stock Investment Pros

High Growth Potential
You can Choose Direct Stocks
You can make money through different strategies
Allows beating Inflation

High Growth Potential -

In the long run, stocks have higher growth potential if the investor selects the right company. Growth stocks have a history of outperforming the benchmark index over a long period. Usually, shareholders enjoy two types of capital appreciation.

The price appreciation
the dividend.

With the growth in the economy, the sales, as well as the income of the companies go up. It reflects in the price of the shares.

Investing in several stable companies of different sectors helps the investors to take full advantage of the economic growth.

Some companies pay dividend to the shareholders regularly.

The investors are entitled to get the dividends even if the shares have lost value, i.e., they are trading at a lower price than the acquisition price.

Shareholders can either reinvest the dividend or take it home.

You're your Manager -

While investing in stocks, the investors themselves take the buy and sell decisions, i.e., when to buy and when to sell the shares.

It helps in cutting the losses and restructuring the portfolio whenever it's necessary.

Sometimes, the price of the shares of individual companies starts declining sharply on the back of bankruptcy or a piece of negative news. These shares may find it challenging to come back to their past highs. In such circumstances, the stockholder can replace that company with a better performing one and thereby reduce the losses.

With the change in the ecosystem, a periodic rebalancing in the portfolio is essential.

In stock investments, the tax consequences are within the investor's control. As the gains from the sale of shares are taxable according to short-term/long-term capital gains, the individual investor can decide when to sell the stock.

Helps to make money through different strategies -

In stock market investing, the individuals have the option to make money through various strategies like buy-and-hold investing, value investing, growth investing, buy the dip investing, and also through day trading.

Short selling is another way to make money in the stock market when an immediate correction price correction is expected.

Allows beating inflation -

Long-term stock market returns can usually stay ahead of inflation. Stocks have a history of giving an average annualized return of 10%.

Stock Investment Cons

Longer Reward Period
Need Extensive Research
Last in Line
High Volatility

Longer Reward Period -

To get a substantial reward, the investors need to stay in the stock for a very long time. Even after investing in a company, the shareholders need to monitor the price regularly.

Track the news pieces to see the activities in the company are also inevitable. In the long run, these are complicated if your portfolio contains the shares of 15-20 companies.

Need for Research -

To find quality stocks, proper research on them is essential. Research on companies involves reading charts, financial statements, and annual reports.

If the investor has no experience, then an understanding of these things looks impossible. Even for an experienced investor, understanding the fundamentals may take many days.

Last in the Line -

In worst circumstances, i.e., if a company goes bankrupt or if its assets liquidate, the common shareholders get the last preference in the money.

The bondholders get the first preference, followed by the preference shareholders. If any part of the assets left after distributing to these two categories, which goes to the individual shareholders, and in most cases, it'll be nothing.

Highly Volatile -

The price of the stock moves up and down continuously. Stock market investments are exposed to various types of risks.

The factors inside the company, as well as political and market events can influence the share price. So there is no guarantee in the returns and the investor may lose all the money that he/she invested in stocks.

Pros of Mutual Funds Investment

Professional Management
Great Convenience
Vast Range of Investment Options

Professional Management -

Unlike stock investment, mutual funds are managed by experienced professionals. Depends upon investment objectives of the fund, they park the pooled money in various assets.

On behalf of the investors, the fund managers take the decisions on buy/sell, asset allocation and also research on different financial instruments.

Great Convenience -

The mutual fund offers excellent convenience to the people who have no time to manage an investment portfolio.

Apart from this, funds give investors the choice of reinvesting the dividend and interest. It helps them to add more fund shares in the portfolio without any transaction charges.

Even the investors have the option of investing a small or a large sum in the funds, depend upon their financial position.

A Vast range of Investment Options -

Investors can select funds depends upon their investment goals from the wide variety of funds. There're options for aggressive investors, risk-averse investors, and also for people whose retirement is on the card.

Cons of Mutual Funds Investment

Higher Fees and Expenses
Lack of Control
Lock In Periods

Higher Fees and Expenses -

Running a mutual fund is very expensive and fund houses pass these expenses to the investors. So mutual funds are expensive than any other investment option. Regardless of the performance of the fund, the investors need to pay sales commission and annual fees.

However, buying directly from the fund houses minimizes the fees.

Lack of control on your Investment -

In mutual funds, the fund managers buy and sell the securities from time-to-time to balance the funds. Here the investors have no control over these decisions, but they owe tax on any gains from these sales.

It may impact the tax planning of the investor. In short, the control of your portfolio lies in the hand of the fund managers.

Lock-in Periods -

Several mutual funds have a lock-in period. The lock-in period varies from fund to fund depends upon the category.

The fund managers keep a portion of the asset in cash to pay to those investors who wish to exit.

The value of this portion of money never appreciates as they are un-invested money. That, in turn, impacts the return of the funds.

The Bottom Line

Mutual funds are designed for people who've no time to track their portfolio. It's also for those who're looking for diversification. On the other hand, stocks are for those who can afford higher risk as well as have time for research and analysis of different companies.

It's perfect for young investors who have a higher risk appetite. If anything goes wrong in their portfolio, they have got the time to recover it.