Whether you’re investing for your retirement or simply wish to earn some extra money by playing the stock market, you might be overwhelmed by the sheer range of investment options available to you. There’s a good reason that financial professionals must attend college for years and pass rigorous examinations in order to be deemed fit to participate in the securities markets: These markets are tremendously complex and involve substantial risks that may be difficult for regular folks to understand.
Differences Between Single Stocks and Mutual Funds
Many investors put the majority of their assets in stocks or mutual funds. Historically, both investment classes have produced solid returns and offered acceptable amounts of risk for the individuals who choose to use them. While it’s always risky to make conjectures about future outcomes based on a given investment class’s past performance, it’s probable that stocks and mutual funds will continue to provide favorable rates of return for mainstream retail investors.
If you’re not terribly familiar with the financial markets, you may have some questions about the differences between stocks and mutual funds. While they’re functionally similar in many regards, there are also several important distinctions between these two investment classes.
First, mutual funds are generally regarded as less risky than individual stocks. This is because most mutual funds are comprised of :
- Multiple stocks
- Other liquid securities
This diversified approach to investing helps to mitigate the potential negative effects of a “bad” mutual fund component.
For instance, the poor performance of a mutual fund stock that drops by 30 percent over the course of a month is likely to be offset by the “average” performance of the fund’s 20 other component stocks. A mutual fund that rises by 10 percent during a period in which the broader stock market rises by just 5 percent is likely to be lavished with praise.
Although mutual funds are less risky than individual stocks, they also provide fewer opportunities for impressive gains. Under the right circumstances, certain single stocks can appreciate by 50 to 100 percent within the course of two or three trading days. This typically occurs in response to stock-specific situations like leveraged buyouts, takeovers, or other events. The laws of probability dictate that such events can’t affect the performance of a mutual fund to such an impressive degree. Although a mutual fund might appreciate by 30 percent over the course of a year, a single stock might appreciate by the same amount over the course of a single day.