How are mutual funds different from stocks and bonds? If you buy a share of stock, you own part of that company. For every share you buy, your ownership increases. Stocks are equity investments because you have equity in the company. In order to make money with stocks, you have to sell your stock at a higher price than you purchased it for a capital gain.
If you buy a bond, you have lent money to the company for a specified period of time. You do not own any of the company. In order to make money with bonds, you lend money to the company, and every year or six months, they pay you interest. When the time is up and your bond has reached maturity, the company repays the money you lent them. You also have the option of selling the bond before maturity.
A mutual fund is simply a mix of stocks, bonds, or both. They often include other investments as well such as derivatives. A large amount of people pool their money together and purchase a wide variety of securities. This allows those with little to invest to be able to diversify their portfolio. Instead of buying shares of stock in one company or a handful of companies that you choose, or buying bonds of different companies, you buy shares of a mutual fund. A fund manager assigned to that mutual fund manages the portfolio and chooses the investments. You make money similarly to stocks by selling your mutual fund shares for a gain.
Now you know how are mutual funds different from stocks and bonds but which should you invest in?
You may be wondering why you would invest in a mutual fund if you could just buy the stock or why you would buy the stock or bonds if you could just invest in the mutual fund. Basically, you are wondering why you would choose one over the other when they include the same things.
One benefit of a mutual fund is that if you have a small amount of money, you will be able to diversify your portfolio. For example, if you want to invest $1,000, you may only be able to invest in a few different companies because you can only buy whole shares of stock. Similarly, if you want to buy a bonds, you would probably only be able to buy one, which would be risky in that you’d either get a very low rate of return, or lose all your money if the bond turned bad.
A mutual fund is foolproof diversification. You don’t have to choose the right stocks or bonds, which leads us to the next point. If you are the average person and don’t have a college degree in finance, it’s likely you don’t know much about investing. If you don’t know how to research and pick stocks, you are probably wary of your own choices, worried that you might lose money. With mutual funds, a fund manager makes the choices, so you can feel a little more confident in the chosen stocks. Also, you can see a funds past performance when choosing a mutual fund. This helps give you a little more piece of mind. Ultimately, mutual funds are great for the average person who doesn’t have a lot of money to invest, a lot of knowledge about investing, or the time to spend choosing investments and managing a portfolio. Now as you know differences between mutual funds, stocks and bonds it’s time to decide which option might work best for you or try all of them.