There are several ways that you can invest in stock markets. You can invest in stocks on your own, or you can entrust a fund manager to invest on your behalf through passive or active investing. ETFs follow a passive investing strategy, while most mutual funds are actively managed. Are mutual funds or stocks better for you?
Stocks or mutual funds: Which is better?
A mutual fund is a pooled investment vehicle where the fund manager decides which securities to invest in. You invest on the premise that the manager is better equipped at stock picking, and pay the mutual fund company for managing your money. On the other hand, if you invest in stocks directly, you pay the applicable brokerage rates that your broker charges. But it's you who decides on what stocks to invest in and when to buy or sell.
Many investors tend to have concentrated portfolios that are heavy on a particular stock or sector. While this could give you the advantage of a “home run” or massive gains if your call is right, you also lose more if your call is wrong. Investing in stocks is riskier than investing in mutual funds, which have a diversified portfolio with many stocks.
Buying stocks versus mutual funds
Buying stocks directly is often cheaper than buying mutual funds. However, if you have expertise in stock analysis, a risk appetite, the time to review your investments, and the ability to stay rational amid volatility, you should invest in stocks. Otherwise, a pooled investment vehicle such as an index mutual fund or ETF may be better for you. Berkshire Hathaway chairman and legendary investor Warren Buffett also thinks that some investors may be better off with an S&P 500 index fund.
Stocks, mutual funds, and ETFs
Active fund managers' record hasn’t been great. In 2019, 71 percent of large-cap fund managers underperformed the S&P 500, marking their tenth consecutive year of underperformance according to their SPIVA (S&P Indices versus Active) scorecards. As a result, investors have been pivoting to passive funds such as ETFs, which charge lower fees and deliver returns in line with the index after adjusting for costs.
Stocks or mutual funds for retirement?
You can also choose either stocks or mutual funds for your retirement portfolio. For retirement, you should take a long-term approach and invest in growth stocks. Don't focus so much on short-term performance.
At Berkshire Hathaway's annual shareholder meeting in 2020, Buffett emphasized the importance of buying stocks for a long period. He said, “But I hope that really everybody would buy stocks with the idea that they’re buying partnerships in businesses and they wouldn’t look at them as chips to move around, up or down.”