Stocks and Mutual Fund Basics
Both stocks and mutual funds are securities that can be held in virtually any brokerage account. Investing in stocks, bonds, and funds is the cornerstone of any investment portfolio.
Each share of stock represents the direct partial ownership of a publicly traded company. As the owner of an individual stock, the investor has certain rights, including voting for the company's Board of Directors, and voting on any proxy issues submitted by shareholders or the company management. In addition, each shareholder has the right to be paid any dividends declared and paid by the company.
A mutual fund, on the other hand, is an investment pool. Each share of a mutual fund represents a partial ownership of the investment pool. However, a mutual fund shareholder has no direct investment stake in any one company. The management team of the mutual fund has the right to vote for and against proxy items and the Board of Directors. Furthermore, while a mutual fund must pass through all dividends and capital gains to shareholders, it does so on a cumulative basis. Dividends are paid as specified in the mutual fund prospectus. As a result, a fund shareholder may not receive a paid dividend if they sell shares of the fund before the dividends are paid.
Investing in Stocks vs Mutual Funds
When choosing how to invest funds in a brokerage account, there are many factors to consider. First and foremost, the investor must consider the time and effort they plan to commit to their investing portfolio and strategy. Researching individual stocks can be time consuming. Investors without sufficient time to devote to managing their investments are therefore, typically better off investing in mutual funds. Researching mutual funds is generally less time consuming.
Additionally, financial experts recommend that investors diversify their portfolio among various companies, sectors, geographic regions, and market capitalization, or size. Doing so with individual stocks can require a significant amount of money. Buying just 100 shares of IBM stock can cost well over $10,000. Investing in several similar companies would add up quickly.
However, for investors with enough capital and time to commit to their investments, individual stocks can be a better investment choice. When investing in individual stocks, investors have more control over timing their buys and or sells. For example, an investor can generate capital losses at the end of the year for tax purposes, or conversely defer selling into the following year to avoid incurring a capital gain.
In addition, long-term investors in individual stocks need not worry about the drag on investment performance caused by mutual fund expenses.
Investing in Stocks and Mutual Funds
For most investors a mixture of mutual funds and individual stocks will make the most sense. A portfolio composed of well-researched stocks purchased and sold by the investor in areas where there is both expertise and comfort, coupled with investments in mutual funds to cover the other areas is a sound investment strategy. Small cap companies and international investing are two areas where most investors have neither the resources nor the confidence to invest well.
When it comes to evaluating stocks versus mutual funds in a brokerage account most investors will be best advised to combine the two in a way that matches both their ability and their available time.
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References: FINRA (formerly NASD), and the SEC.