Stocks vs Mutual Funds

This is the age-old question! A lot of people ask me what should they invest in, stocks or mutual funds? That's kind of a difficult question to answer, since most mutual funds are comprised partly (or in some cases fully) of stocks anyways. There is no general right answer for the entire population, so we must look at the differences of investing in 'single stocks' over mutual funds.


Mutual Funds are one of the most talked about and well-known investments available in Canada. We see them on TV, hear about them from our Advisors/Bankers, and also are one of the broadest investments we have access to.

Seems everybody has heard of "Mutual Funds", but not many actually understand what they are or how they work. Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:

There are a group of people who all are investing into a pool of money, which is then invested into a company. That company has Professional Money Managers who then go and buy and sell certain investments (stocks, bonds, cash etc..). The sole purpose of these managers is to buy and sell investments and to get the best returns they can; they look over the balance sheets, income statements, research companies, look at executive statements etc... They are managing all the money that is invested with them, and the fund will earn a rate of return (either positive or negative -- hopefully positive). For doing this service, they charge an MER (Management Expense Ratio), which is like the 'service fee' so to speak for doing all that work.

In a nutshell, that is my very 'general' explanation of what a Mutual Fund is. Many mutual funds are comprised by a good percentage of stocks; usually ranging from about 20% to about 80% (there are some funds who have less then 20% stocks and some who have 100% stocks). Mutual Funds are designed for all types of investors, ranging from those with absolutely 0 level of market risk, to those who can stand a lot of market risk and go completely aggressive.

Now, both stocks and mutual fund investing CAN be profitable, however, both are risky as well. Let's take a look at some points on both types of investments.

Stocks:

- Investing in one company at a time
- If that company tanks, your investment tanks
- You have to use your time and energy to buy/sell, research etc...
- No Management fees
- Can be very expensive to buy each stock of a company
- Per transaction fees (buying and selling)
- More control over your investments
- More flexibility
- A lot more risk

Mutual Funds:

- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100 (or more) stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk
- Management Fee charged
- Less control
- If a few of the companies within the mutual fund tank, it will not affect your investments as much (risk is balanced)

Both of these types of investments have the potential for positive or negative growth, and both have some sort of degree of risk attached to them. Generally, stocks have a higher potential to get higher gains. We've all heard of stock prices doubling or tripling in a short period of time if that specific company has substantial growth or good news coming out of it.

That being said, stocks also have a higher potential for a lot more losses. From my experience, the average investor (not institutional or big money investors) who invests only in stocks, has between 3-5 stocks in their portfolio. Now, if one of those companies goes down the drain, then potentially that can be 20% (or more) of your portfolio (depending on how much was invested in each company).

These days it can be hard to determine which companies will grow and which companies will fall. In recent times we've seen several HUGE companies go belly-up, so stocks require a lot of research and analysis in the market.

Some people try to 'time' the market, but this can be a HUGE challenge because in order to time the market properly you have to be right TWICE: first, when you buy, and second, when you sell. Even the most experienced traders and analysts have trouble timing the markets properly and many of them have lost a LOT of money when trying to do it.

Mutual Funds, in my opinion, are more seen as 'steady growth' over a longer period of time. They can be a better indicator of the performance of the broader market as a whole, rather then just one company. If, for example, a fund had 50 companies in it, and 5 of those went belly-up, that would not have as big an effect as if 1 out of 5 stocks went belly-up. So the risk is often spread out over different companies, sectors, and geographical regions, among other things.

Generally, for mutual funds, it is more of a long term investment. So, usually, you're not trying to 'time the market', because there should be the hope or expectation that in the long run the money will grow and compound anyways. It can be seen mostly as a 'buy and hold' type strategy (keeping in mind you're not in the same mutual fund for the entire period of your investment; I think it is key to be switching every now and again to make sure you're diversifying properly and keeping up with market trends).

It is clear that each strategy has its advantages and drawbacks. I generally suggest that the average person should not invest in stocks, because of the time and energy that is required to be devoted to do it. Most people do not have neither the time, the energy, nor the patience to do stock-picking. Why would you gamble with your future with something you're not able to commit proper time to?

Remember, we are all responsible for our decisions, whether we decide to invest in stocks, mutual funds or any other form of investments. One of the biggest causes of a portfolio going downhill is that we rely on other people for our advice. Some of these outside sources include Magazines, T.V., Radio, Newspapers, our friends, family etc... If you solely rely on these for stock picks, then you really should re-consider going into stocks.

Generally, for an 'average investor' I would recommend that if they are to do stock purchasing, to do so only with money that they are 'able to lose'. Meaning that if they lost that money because of that one company they invested in going out of business, then it wouldn't put them in a tough financial position. Sort of like, 'gambling money'; if you win, great, if not, no sweat off your brow!

Also, whenever making any decision, please consult a financial professional (your financial advisor/planner). If you require any more information, please do not hesitate to contact me. I hope this has been helpful!