Difference between Mutual Funds and Stocks

Key difference: Mutual funds and stocks are two different types of investment options available. Stocks are equity instruments that offer ownership in the company in exchange of money. The investor invests capital in return for voting rights in the company. While, one can buy the stock of a company, one can also invest in a mutual fund. Instead of just buying the stock of one company, the mutual fund invests in the stock of a number of companies.

Mutual funds and stocks are two different types of investment options available. Both allow a person to invest in the market in order to increase one’s earnings. Essentially both have to deal with the stock exchange, but in different manners.

According to Investopedia, stock is defined as “a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings… Also known as "shares" or "equity".”

When an investor purchases a stock of the company it also purchases ownership into the company. Companies issue stocks as they are a faster, easier and a safer way for them to raise capital. Stocks are equity instruments that offer ownership in the company in exchange of money. The investor invests capital in return for voting rights in the company. The stock of a company is divided into shares, where a person purchasing one or more shares of the companies can identify himself as a stock owner. Shares can be issued at the start up of a company or at a later time when a company becomes more stable, it can also issue additional shares depending on its net worth in the market. The price of a company’s stocks depends on the company’s worth in the market.

There are two main different types of stockholders, preferred or common. The more common being well, common. A common stockholder has voting rights in the company and can exercise this right in corporate decisions. A preferred stockholder, though also has ownership in the company, does not have voting rights. The only benefits that preferred stockholder has is that any profit the company makes they are the first to receive a dividend before any dividends can be issued to other shareholders. A person investing in a company receives a stock certificate, a legal document that species the number of shares the investor holds. Shares are considered a dynamic investment since the investment of a stockholder is affected depending on a company’s profit and losses. It is a much safer option for a company, as the company is not entitled to return payment in case it is in loss. Stocks are an attractive investment as they can be a short-term investment or a long-term investment.

Stocks are listed on the stock exchange. One can view the stocks of different companies as listed on the exchange. It allows stock brokers and traders to trade stocks, bonds, and other securities. A stock relates to a particular company. While, one can buy the stock of a company, one can also invest in a mutual fund. Instead of just buying the stock of one company, the mutual fund invests in the stock of a number of companies.

Investopedia defines mutual fund as, “an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.”

The advantage of a mutual fun is in the fact that one does not require that much knowledge of the market. In order to pick a stock, one needs to do research and pick a stock out of potential hundreds of companies. One then needs to monitor the company to ensure that it is growing and that it will provide a good return on investment, in addition to if and when to sell the stock.

However, in case of mutual funds, one only needs to pick a successful mutual fund and the mutual fund does everything for you. The mutual fund pools money from a number of investors and then invests that money in a number of company stocks. The investor need not put the time or effort to pick the stock. The mutual fund manager will pick and invest in a number of various stocks, be it 20, 50 or 100 companies. The fund will also ensure that the investor see returns on the investment. There are many types of mutual funds. Some are pure or a mixture of equity, debt, commodities, foreign-indexes, etc. They might be sector based funds such as tech, financial, retail or energy.

Another advantage of mutual funds is the fact that they are diverse in their holdings. While this does mean that any single stock won’t improve the fund’s holding overnight, it also means that it won’t ruin it either. For example, if among the funds holding’s one of the company’s stock is Microsoft, Inc., then even if the stocks of Microsoft increase to double it will not make that big a difference on the mutual fund, as Microsoft probably only makes up 1% or 2% of the fund’s holdings. However, if suppose in the future Microsoft’s value drops to half, it still wouldn’t make that much of an impact on the fund’s holdings. Hence, the investor is protected from the risk of loss.

A disadvantage of mutual funds is that the investor does not have a say in which stock his money is invested. Once the investor invests in the mutual fund, it is the mutual fund manager’s say so as to which company’s stock is bought and sold. In single stock holding, the investor has all the control over the investment.

Due to the various advantages and disadvantages of stock and mutual funds, many investors choose to invest in both stock and mutual funds, in addition to other investment options such as debt bonds or commodities. Still, many first time investors feel safer with mutual funds as they do not require much knowledge of the market and it also mitigates the risk of loss.

Image Courtesy: scottonmoney.com, topnews.in

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