November 18, 2009
Difference between mutual funds and ordinary stocks
Investors have a choice between different financial instruments. Some of the most common financial instruments are mutual funds and ordinary stocks. Although these two options have similarities, no two things are the same exactly. The similarities include the fact that investors in both cases get a profit based on how high above the initial investment the trade closes and the fact that professionals are involved in most of the procedures. The best way to arrive to a decision on what to invest in is to compare the pros and the cons of both of mutual funds and ordinary stocks.
Diversification
The greatest difference between mutual funds and ordinary stock is diversification. Mutual funds are all about investing in different financial instruments such as stocks, options, foreign currencies, commodities and bonds. With ordinary stocks, an investor only has to deal with ordinary stocks. The fact that fund managers can diversify the portfolio in mutual funds is a big pro and it is a big con for ordinary stocks because diversification means a lower risk to the portfolio and higher returns since you make money with some instruments even as others are making losses.
Day trading
Although many investors prefer to enlist the services of brokers, it is possible to day trade with ordinary stock. However, all mutual funds are run by professional fund managers. Day trading is important because you can pay 100% to your stock and you will not pay commissions to agents. However, it is important to note that professionals are important because they have theoretical knowledge, they have experience, the know how to use different analytical tools to predict market trends, and they have valuable networks. When you do day trading, you have to pay 100% attention to your investments since the difference between profits and losses is usually a result of split second decisions.
Long term and short term investments
Mutual funds are the better option for those who want to invest long term, such as those who are investing for their retirement. On the other hand, investors in ordinary stocks are usually people who want some quick cash. This is because no one can accurately predict how an ordinary stock will do in, say, 20 years since a new competitor can enter the market, and/or the company can go bankrupt, among other scenarios. With mutual funds, the portfolio is diversified and it undergoes regular rebalancing to reduce risks.
Minimum investment
Most mutual funds have a minimum amount that is required from every investor. On the other hand, you can invest as little as is on offer with ordinary stocks. Investing in ordinary stocks is therefore better than investing in mutual funds for small investors who do not have much to spare.
Exiting the trade
It is easier and cheaper to exit a trade in ordinary stocks. This is because all you pay is a commission to the agent – this is usually less than 5% of the value of the trade. On the other hand, you have to pay a redemption charges on top of the normal sales commissions and operating expenses when exiting mutual funds.