Differences between stocks and mutual funds
Mutual funds are diverse stock holdings which are managed on behalf
of the investors who buy into the fund. Mutual funds allow investors to
take advantage of a diversified portfolio without the need of investing a
large sum of money.
A diversified portfolio carries the advantage of offering protection
against the rapid market losses of any particular stock. If stocks lose
their value, the effect will be less if they belong to a portfolio that
is spread across twenty stocks than if they belong to a portfolio that
is consist of a single stock.
Diversification is always a good idea in making investments. The
problem for small investors is that usually don’t have enough funds to
buy a variety of stocks. Despite their limited funds, small investors
benefit from diversification through mutual funds.
Mutual funds, aside from stocks, can be consisted of a variety of
holdings that include bonds and money market instruments. Mutual funds
are actually the companies and the investors are really the company
share buyers. The shares in a mutual fund are either directly bought
from the fund itself or indirectly bought from the brokers who represent
the fund. Selling them back to the fund is a way of redeeming shares.
There are some funds which are managed by investment professionals
who decide on which securities to include in the fund. Non-managed funds
are also available. Indexes, such as the Dow Jones Industrial Average,
usually serve as the bases for the funds. The funds, which simply
duplicate the holdings of the index where they are based on, rise by a
percentage that is the same as that of the chosen index. Non-managed
funds often perform well and they sometimes perform even better than
managed funds.
Mutual funds also carry some downsides. Aside from paying some fees
no matter what the performance of the funds is, individual investors
also have no say in which securities have to be included in the funds or
not. In addition to this, the actual value of a mutual fund share is
not as precise as that of the stocks on the stock market.
For small investors, a mutual fund is still considered to be a better
choice than either stocks or bonds because they offer the diversity
that provides cushion against unpredictable stock market movements. They
also provide a greater return than bonds. Mutual funds can also lose
value especially in the short term. Short-term investors are better off
with bonds that offer a set rate of return.
The three main types of mutual funds are money market funds, bond
funds, and stock funds. The type that offers the lowest risk, money
market funds consist solely of high quality investments like those which
are issued by the US government and blue chip corporations. Although
they rarely lose money, money market funds also pay a low rate of
return.
The aim of bond funds to produce higher yields than money market
funds caused them to carry a correspondingly higher risk. The risks that
are associated with bonds, such as company bankruptcy and falling
interest rates, are also applicable to bond funds.
The types of funds that carry both the greatest potential for
profitable investment and the greatest risk for losses are stock funds.
The risk in stock funds is mostly for short-term mutual fund holders
because stocks have traditionally outperformed other investment
instruments in the long run.
There are different types of stock funds including ‘growth funds’
that attempt to maximize capital gain and ‘income funds’ that
concentrate on stocks that pay regular dividends.
Those with limited funds or investment experiences are recommended to
invest on mutual funds. When choosing the right fund, investors have to
consider how much risk they are willing to take against their expected
investment returns.
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