Home » Writings and Commentary » Stock Market Analysis » Individual Stocks Versus Mutual Funds: Which is Right for You?

Investing in individual stocks versus mutual funds is a time-honored debate in high finance. For such a personal decision, it is critical for you to appraise the differences in investor rights, financial risks versus rewards, and valuations that define these asset classes.

Yes, we do acknowledge the overlap between individual stocks and mutual funds and will be writing in generalities.

Investor Rights

Individual shares of common stock represent corporate ownership rights, in exchange for putting up capital to front the business concern. Shareholders elect a board of directors, which in turn hires management to run the business.

Mutual funds are investment pools managed by a professional. Mutual fund investors are not granted voting rights, nor control over any investments held within the fund.

The mutual fund issues a prospectus, which spells out objectives and fees. Federal law enforces the 75-5-10 fund diversification rule: 75% of fund assets must be invested, only 5% of fund assets may be invested in one company, and only 10% of one issuer’s securities may be owned.

Asset Allocation, Risks, and Rewards

Individual stocks are associated with business risk, which defines the potential for a certain business to fail due to competition, inadequate financing, or poor leadership. Early, ground-floor investors who bought into the likes of Nike, Starbucks, Microsoft, and Apple, of course, are now sitting atop generational wealth.

Portfolios featuring larger numbers of stocks will mitigate business risk. Private investors, however, may lack the funds and expertise to assemble large portfolios on their own.

For smaller investors, one mutual fund share offers automatic diversification, as the aggregate pool may lay claim to dozens of securities. Logic would have it – that a fund owning hundreds of investments would simply track the broader market. For this, we have index funds, which are coveted for their low cost.

Share Price Values

The price of stock is set with each trade per auction markets at worldwide exchanges, such as the New York Stock Exchange.

Closed ended mutual funds also trade on organized stock exchanges, and prices often swing wildly away from the real value of the portfolio. Alternatively, open-end funds are bought and redeemed directly with the mutual fund company at net asset value (NAV). We calculate NAV at the end of each trading session by dividing fund’s assets by shares outstanding.

Fees and Taxes

Individual stocks are bought and sold through a broker that will charge fixed-rate commissions for his services. Brokers will also pocket the spread, or the Bid-Ask stock price differential. Investors will trade shares strategically to manage their respective capital gains. Tax loss harvesting is a common tactic in late December, when investors dump losing stocks, as tax write-offs.

Open-end mutual funds charge management fees as a percentage of assets under management. Further, mutual fund investors have no control over taxes, and pay their respective share of capital gains taxes on distributions according to the independent trading activity of the fund manager.

Investment Strategy

Sophisticated investors will prefer buying into individual stocks, for higher levels of control, voting rights, tax management, and potential returns. Alternatively, mutual funds are better suited for small, passive savers who may now also access professional money managers and automatic diversification.

Most investors will sit above a mix of both mutual funds and individual stocks within their respective portfolios. Your 401(k)-retirement plan at work will likely offer up a mix of large capitalization, small cap, international, bond, and money market mutual funds. Billionaire investor Warren Buffett himself does own index mutual fund shares through Berkshire Hathaway and his personal accounts.