Mutual funds and stocks can be considered as long-term investment products as they both provide long-term returns. However, choosing between them can be difficult. This is especially the case if you are new to investment. As a beginner, you would like to understand the differences between mutual funds and stocks. You would equally want to know the advantages and disadvantages of mutual funds vs. stocks. Consequently, it becomes uncertain whether to invest in mutual funds or buy stocks directly.
Even though there are differences between mutual funds and stocks, they also share some similarities. A number of factors can be considered when it comes to the differences and similarities of mutual funds vs. stocks. Therefore, if you’re still wondering whether to invest your money in mutual funds instead of stocks or choose stocks over mutual funds, then the following review can serve as valuable information.
[Note: Mutual funds as used in this write-up refer to either equity or balanced funds]
Mutual funds vs. stocks: Mutual funds are generally managed by professionals
A major benefit of mutual funds over stocks is the professional manner by which they are managed. Mutual funds can be seen as passive investment whereby one invests his money, relax and put his faith in a fund manager to take care of the rest. As a result, investing in mutual funds may not need much dedication and time, thus fairly suitable for beginners. Even though it is useful to know how your funds are being managed, it may not be that necessary to study into detail, how each individual company in the mutual fund’s portfolio is performing. Obviously, you should have an idea of the mutual fund’s performance over the years.
On the other hand, one may require extra time and dedication to invest directly in equities (stocks). Time may be needed to go through financial reports of companies, observe trends of stocks performance, decides on best trading strategy and many more. Monitoring and picking of stocks can therefore be best handled by investors who have at least some basic knowledge in stocks as well as more time to spare. As you may agree, not everybody is well informed or knowledgeable to monitor and pick the right stocks.
Mutual funds vs. stocks: Stocks permit active participation unlike mutual funds
There are a few investors out there who prefer to be actively involved in the investment activities. Such group of people would like to have full control of their invested money instead of being handled by others. As explained in the previous point, mutual funds are managed by professional fund managers. Fund managers decide where and how to invest the money, which limit the active participation of investors. Stocks, on the other hand, allow investors to have control of their investment. As an investor in stocks, you know the exact companies you invest your money. By investing in stocks instead of mutual funds, you become actively involved.
Moreover, you have the right to vote during annual shareholders meetings of the companies you have invested in. Let’s assume two individuals who decided to invest portions of their income. One invested directly in GCB bank stocks whereby the other invested in Epack investment fund. The one who invested directly in GCB stocks is qualified to attend and vote during GCB annual shareholders meetings. On the other hand, the other investor does not qualify to attend GCB shareholders meeting even though Epack investment fund (where he invested his money) may hold substantial shares in GCB bank.
Mutual funds vs. stocks: Prices of mutual funds are more stable compared to stocks
Prices of stocks fluctuate many times during the day unlike mutual funds. For example, a stock would begin trading at GH 10.5 per share and the next moment drops to GH4.5 within the same trading day. Due to this, it is not unusual to buy shares of the same company at different prices on the same trading day. Prices of mutual funds, on the other hand, change once in a business day. The fund managers determine the unit price of the mutual funds only after stock market closes.
Mutual funds vs. stocks: Mutual funds and stocks involve fees and commissions
There are fees and commissions involved in both mutual funds and stocks. Nevertheless, the fee structure of stocks appears simpler to understand. Currently, the maximum total fees and commissions for buying stocks from the Ghana Stock Exchange is 2.5% of the purchased shares. This can be broken down into two parts:
- Statutory fees to the GSE and SEC (Security Exchange Commission)
- Commission to the stock broker
In contrast, fees and commissions for mutual funds consist of many details. These are either charged directly or indirectly on the funds. A typical fee structure of mutual funds is made up of the following:
- 1-3% back-end load for withdrawals made before 3 years
- 2% of fund’s net assets as management fees
- Directors’ emoluments
- Audit fees
- Registrar fees
- Bank charges
- Professional and consultancy fees
- Marketing/promotion/advertisement fees
- Operational and administrative expenses
[For details on investment fees and commissions, refer to this link.]
It must be noted here that the above fee components of mutual funds (except back-end loads) are charged annually on the fund. These numerous fee components are what investors sacrifice in exchange for professional management of the funds. While the fees and commissions may seem high, most mutual funds are known to outperform the GSE all-share index on many occasions.
Mutual funds vs. stocks: There is real feel of dividend payments when invested in stocks
Investing in stocks come with the benefit of earning regular income in the form of dividend payments. Whenever dividends are paid, investors who purchase stocks directly have easy access to the paid dividends. They have the option to either reinvest the dividends or cash them without the need to sell off some shares. On the other hand, dividends received by mutual fund companies are generally reinvested in the fund without distributing them to the investors. While this helps the fund to grow, it however restricts investors who may want to use their dividends as a regular income source. In a way, investors in the fund do not have the option of immediate access to their dividends. The only means for them to cash the dividends is to sell some units (shares) of their mutual fund investment.
Let’s assume that you invested GH¢500 in SAS Fortune fund on the 30th of December 2016. The offer price of SAS Fortune fund on 30th December 2016 was GH¢0.5329 per share. Thus, investing GH¢500 at the time would entitle you to 938.26 shares [Note that fractions of shares are permitted in mutual funds]. On the same day, you further purchased GH¢500 worth of shares in GCB Bank Limited (GCB). The closing price of GCB stocks on 30th December 2016 was GH¢3.56 per share. Hence, GH¢500 could buy about 140 shares of GCB (without considering fees and commissions). Now, in June 2017, GCB Bank paid shareholders a dividend of GH¢0.38/share. For owning 140 shares of GCB, you would be paid GH¢53.2. Since SAS Fortune fund also invest in GCB Bank, the fund would also receive dividends from the bank, which would be integrated in the fund’s earnings. For your shares in GCB, you have immediate access to the paid dividend of GH¢53.2 while your total shares of 140 stay intact. On the contrary, you are restricted from having immediate access to the dividend integrated in SAS Fortune fund. To some extent, you would need to sell off (liquidate) some of your 938.26 shares in the fund in order to do so.
Mutual funds vs. stocks: It takes much longer to purchase stocks on the GSE
Buying stocks from the Ghana Stock Exchange can take considerable time unlike mutual funds. Depending on the particular stock, it may even take several weeks plus additional settlement days to complete trading transaction. Settlement date, which is the actual date on which the purchased shares get completely transferred to the new shareholder, is three business days from the day the shares are bought. The delay in stocks transaction makes it difficult to quickly fulfil trading plans. For instance, imagine noticing a sharp decline in GCB shares from GH¢4 to GH¢2. At the same time, a media report indicating a successful come-back of GCB shares may be circulating. To take advantage of this, you order your stockbroker to purchase some of the fallen GCB shares. However, due to the associated delay in transaction, you would realise that even before the shares are purchased for you, the share price had bounced back to the initial GH¢4 or even more. In effect, you lose that chance of making gains from the fallen price.
On the other hand, the purchase of units from mutual funds gets completed within the same business day once money is deposited in the mutual fund account. Anytime you make a deposit in an equity [mutual] fund, your shares in the mutual fund are credited on the same business day as long as the deposit is made before closing hours of the day. Besides, unit or share price of mutual funds does not fluctuate on the same day. The only price change is reported after close of trading on the stock market. This could aid effective investment planning.
Mutual funds vs. stocks: Investing in stocks appear riskier than mutual funds
The lack of effective diversification can expose investments to high risks. Diversifying in stocks trading requires an investor to purchase shares from various industrial sectors. Unfortunately, not every investor can individually afford buying many varieties of stocks. This may result in poor investment diversification. On the other hand, mutual funds appear to offer auto diversification for investors. As stated earlier, a major advantage of mutual funds is the disciplined form of diversification. Typically, fund managers follow institutional rules regarding asset allocation of the mutual funds. For instance, a fund manager may be restricted to invest not more than 5% of the fund’s portfolio in a single company. Following these defined guidelines leads to sufficient diversification in different industrial sectors. The result is a well-diversified portfolio with minimised risk and volatility. It must also be noted that mutual funds are not really 100% equity investment. As you may be aware, most fund managers invest a certain percentage (usually 20%) of the mutual fund’s portfolio in fixed income products such as Treasury bill and fixed deposits. Although this is done to increase liquidity of the fund, it further reduces the risk posed by the stock market.
Mutual funds vs. stocks: Mutual funds can be easily converted to cash unlike stocks
As mentioned previously, mutual funds are not invested in 100% stocks. About 20% of mutual funds’ portfolio comprises of cash and fixed income products. These assets can be easily converted to cash, making mutual funds more liquid than stocks. Typically, it takes an average of one to three business days for an investor to withdraw from his mutual fund account. On the contrary, investors who wish to convert their stocks into cash may need to wait for a while until their stocks get purchased on the stock market.
Mutual funds vs. stocks: It requires less money to invest in mutual funds
Mutual fund institutions operate by pooling money from various investors and subsequently investing the collective fund. Each individual can invest according to his financial capability, which makes it more appropriate for starters. Novice investors with less investment capital can therefore choose mutual funds over stocks. For example, an investor with just GH¢50 can start investing in Epack whose minimum initial investment requirement is GH¢50.
In addition to the minimum initial investment, mutual fund investors benefit from the disciplined diversification offered by fund managers. In contrast, one may require enough starting capital in order to achieve an appreciable diversified stocks portfolio. Certainly, it may be very challenging, if not impossible, to properly diversify in stocks with just GH¢50.