When you have long-term financial goals, such as helping pay for a child's college education or funding your retirement, including stock investments in your portfolio provides opportunities for potential growth. But should you invest in individual stocks or stock mutual funds?1
What's the Difference?
When you invest in individual stocks, you are buying a small percentage of ownership in the company that issued the stock. You choose which stocks to buy, sell, or hold in your portfolio. However, if you want to diversify your portfolio -- that is, include a variety of stocks so gains in some stocks help cushion losses in others -- that may be difficult. Adequately diversifying a portfolio of individual stocks requires a relatively large investment of cash.2
When you invest in a stock mutual fund, your money is pooled with the money of many other fund investors and invested in a variety of individual stocks. Since each fund holds a number of different securities, the risk that the poor performance of any one stock significantly affecting the fund's value is reduced. The minimum initial investment in most mutual funds is relatively low, so you don't have to invest a large amount of money right away.
Choosing a Stock Fund
If you decide to invest in stock mutual funds, look for funds that fit your investing goals, risk tolerance, and investment time frame. If you are investing for short-term goals, you may decide to choose a fund with a more conservative investment strategy. If your goals are long term, you may want to select funds with the best potential for long-term growth. A fund's investment strategy is stated in its prospectus.
A Variety of Stock Funds
Stock funds are not one size fits all. They can vary considerably. Some stock funds invest in a broad range of companies in diverse industries. Others focus their holdings on one industry or geographic region. You can determine a fund's objective and investing style by reading its prospectus.
Check Performance Records
Before you choose a mutual fund, check its performance record by comparing it to a benchmark index that holds similar investments. In addition to one-, three-, and five-year returns, make sure you look at 10-year returns to get a more complete picture of fund performance. Keep in mind, however, that past performance does not guarantee future results.
Consider Tax Consequences
When you invest in stock funds, you generally are taxed on the distributions you receive from those funds that are held in taxable accounts. Even if you have the distributions reinvested in the fund, a distribution is still taxable in the year of distribution. You may even have to report a capital gains distribution despite the fact that a fund lost value.
1Investing in mutual funds involves risk, including loss of principal. You should consider a fund's investment objectives, charges, expenses, and risks carefully before you invest. The fund's prospectus, which can be obtained from your financial representative, contains this and other information about the fund. Read the prospectus carefully before you invest or send money. Shares, when redeemed, may be worth more or less than their original cost.
2Diversification does not ensure a profit or protect against loss in any market.