Mutual funds, a type ofinvestment where the money from multiple investors is invested together in several stocks,offer advantages over individual stocks, including diversification and convenience.
Key Takeaways
- A pooled investment such as a mutual fund allows investors to diversify their holdings and reduce investment risk.
- Mutual funds offer convenience because investment decisions are left to a professional fund manager.
- Some investors prefer an index mutual fund, which tracks a market index and generally has lower fees compared with actively managed funds.
Reducing Risk With Diversification
Investing in only a handful of stocks is risky because the investor's portfolio is severely affected when one of those stocks declines in price. Mutual funds mitigate this risk by holding a large number of stocks. When the value of a single stock drops, it has a smaller effect on the value of the diversified portfolio.
For example, suppose a person owns 10 shares each of two stocks, with each sharevalued at $100. If the price of one of the stocks falls by 25%, the value of the portfolio declines from $2,000 to $1,750, a drop of 12.5%.
If the portfolio consists of one share each of 20 stocks, each valued at $100, then a decline of 25% in the price of one stock brings the value of the portfolio from $2,000 to $1,975. This is a decline ofonly 1.25% in the value of the overall portfolio.
Mutual Funds Offer Convenience
In addition, investing in mutual funds is more convenient than investing in individual stocks because the manager of the fund researches stocks and decides which ones to purchase. An investor buying individual stocks has to make these decisions for themselves. However, the downside of this convenience is the fee a fund manager charges, which reduces the amount investors can earn from the fund.
While mutual funds are diversified and convenient, whether investing in them is an ideal way to maximize returns is a matter of debate among economists. Those who support the efficient market hypothesis believe investors who buy individual stocks are generally unable to achieve returns as high as the returns of the market as a whole.
Thus, they recommend people invest in index funds, which are mutual funds that track a market index and generally have low expense ratios. Other economists dispute this hypothesis and argue that buying individual stocks has the potential for higher returns than mutual funds.
FAQs
A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.
Is it better to invest in individual stocks or mutual funds? ›
Stocks are more appropriate for investors who can monitor their portfolios and the stock market for opportunities. Mutual funds are more suitable for investors who want a fund manager to do all of the work for them. Bernat summarizes what investors should consider before choosing the right approach for their portfolio.
What is one downside of a mutual fund? ›
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
What is the biggest advantage to owning a mutual fund over an individual stock? ›
Diversification. Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors.
Is it OK to invest only in mutual funds? ›
Are mutual fund investments safe? Market-linked mutual funds are subject to market risk that can be caused by several reasons such as changes in policy, macroeconomic conditions, pandemics, poor investor confidence and so on. Therefore it is a good idea to go through document papers carefully before investing.
Do stocks give better returns than mutual funds? ›
Mutual funds diversify investments, reducing risk, but also limit potential gains. Stocks offer higher returns but come with higher risk and volatility. Explore key differences between Mutual funds and Stocks in this blog.
What is the average return on mutual funds? ›
Balanced funds
Blend of equity and bond investments. Typically offer average returns between 5% to 8% annually.
What is the biggest problem with mutual funds? ›
Mutual funds provide convenient diversification and professional management through a single investment, but can have high fees, tax inefficiency, and market risk like the underlying securities.
Why mutual funds are not a good investment? ›
However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.
Is a mutual fund riskier than a stock? ›
Mutual funds tend to be less risky than individual stocks, because they are more diversified — meaning they contain a mix of investments.
Advisor Insight. A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.
What is the best mutual fund to invest in? ›
5 Best Mutual Funds to Buy Now
| Mutual Fund | Assets Under Management | Expense Ratio |
|---|
| Vanguard Wellington Fund (ticker: VWELX) | $111.7 billion | 0.26% |
| Vanguard Total Stock Market Index Fund (VTSAX) | $1.6 trillion | 0.04% |
| Fidelity 500 Index (FXAIX) | $512.4 billion | 0.015% |
| Fidelity ZERO International Index (FZILX) | $4 billion | 0% |
1 more rowMay 10, 2024
Are mutual funds safe? All investments carry some risk, but mutual funds are typically considered a safer investment than purchasing individual stocks. Since they hold many company stocks within one investment, they offer more diversification than owning one or two individual stocks.
Should I do single stock or mutual fund? ›
Key Takeaways
Mutual funds diversify investments, reducing risk, but also limit potential gains. Mutual funds are managed by professionals, reducing the need for monitoring, but investors give up control. Stocks offer higher returns but come with higher risk and volatility.
What is the safest mutual fund to invest in? ›
- Canara Robeco Bluechip Equity Fund - Growth. ...
- ICICI Prudential Value Discovery Fund - Growth. ...
- Kotak Bluechip Fund - Reg - Growth. ...
- Nippon India Large Cap Fund - Reg - Growth. ...
- HDFC Index Fund-NIFTY 50 Plan. ...
- ICICI Prudential Nifty 50 Index Fund - Reg - Growth. ...
- UTI Nifty 50 Index Fund - Growth.
1. They don't offer stable returns. The primary reason why mutual funds are considered to be risky deals is due to the fact that the returns they offer are not stable or guaranteed. Since the performance of the fund is linked to the movement of the market, mutual funds only offer returns if the market performs well.
Are individual stocks more tax efficient than mutual funds? ›
Holding individual stocks also makes it easier to take advantage of tax-loss selling than with a mutual fund, because you won't have to wait for the broad market or market segments to sell off to find losses in your portfolio.
Is investing in individual stocks worth it? ›
Investing in individual stocks can generate higher returns than mutual funds and ETFs. The opportunity for higher returns is the primary reason some investors prefer to pick individual stocks rather than funds. Achieving a higher return can help you reach your long-term financial goals sooner.
Is a stock safer than a mutual fund? ›
Mutual funds tend to be less risky than individual stocks, because they are more diversified — meaning they contain a mix of investments.
Why is it so important to avoid buying single stocks and invest in mutual funds instead Ramsey? ›
Well, we like mutual funds because they spread your investment across many companies, and that helps you avoid the risks that come with investing in single stocks and other “trendy” investments (we're looking at you, Dogecoin).
