Though you can invest in the stock market by buying shares of individual stocks, you can also purchase shares of mutual funds, which hold a number of individual stocks. Especially for novice investors, mutual funds offer more convenience and better value than trying to pick individual stocks.
When you invest in a mutual fund, you're investing in a wider range of companies than if you pick an individual stock. Because a mutual fund pools the funds of many investors, you can achieve a diverse portfolio with only a small investment. Paying a $10 commission to buy $100 of stock doesn't make a whole lot of sense because 10 percent of your investment is immediately gone. For that reason, CNN Money recommends investing at least $1,000 in each company to minimize the impact of fees. If you want at least 20 companies in your portfolio, you're talking at least $20,000. On the other hand, you can invest $1,000 in a mutual fund and essentially own a plethora of different companies.
Lower Trading Costs
When you're trading small blocks of stock, the transaction costs often end up being a higher percentage of the purchases and sales than when a mutual fund trades much larger blocks. For example, if you pay a $20 commission on a $1,000 trade, you're essentially paying a 2 percent commission. If you make five trades a year, you've already paid 10 percent of your investment in fees. With a mutual fund, the cost of selling off stale investments and purchasing new ones is lower because it's spread among all the investors.
When you invest in a mutual fund, your money gets managed by a professional investor whose job is to watch the market and pick winning investments. Unless you're a full-time trader, the manager and the fund's team are going to have a lot more time to research and pick individual investments than you. For example, say you buy 100 shares of a company on your own. If, while you're on vacation, bad news comes out about the company's future prospects, you might come back to your stock being worth half of what it was before you left. If you have a mutual fund, the management team will be watching the fund all the time so you don't have to worry about it. Even if you're investing in a mutual fund that tracks a particular index, you're still getting managers who make sure that when the index changes, so does the makeup of the fund. These index funds typically carry much lower expense ratios than the actively-managed funds, and, according to Business Insider, often outperform them as well.
Depending on your level of investment experience and expertise, you might not do so well in picking individual stocks. For example, if you haven't delved into an annual report before, picking individual stocks might not be the wisest decision. When you invest in a mutual fund, you get the expertise of the management team. Of course, there are fees involved, but the costs are spread among all the fund investors and you can pick funds with lower expense ratios.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."