Stocks versus Mutual Funds

The major part of a mutual fund is a portfolio of a wide range of stocks that are managed on behalf of the investors that buy into the fund. Mutual funds were created to give small investors to take advantage of a large, diversified portfolio without the need of large investments. The major advantage of a diversified portfolio is the increased protection against rapid market fluctuations of any one particular stock.

As mutual funds' portfolios are spread across 20 or more stocks, even if one of those stocks falls, the effect is much less than if the portfolio consisted of that one stock only. The main rule of investing is “diversify whenever it is possible”. Of course, it is a problem for small investors - they often lack the funds to buy a wide variety of stocks. And that's where mutual funds comes in, letting small investors to benefit from diversification only after investing a small amount of money.

Mutual funds can be made up of a variety of holdings, not only the stocks. Their portfolios might include also bonds or other money market instruments. Technically speaking, a mutual fund is a company and those who buy into it are in fact purchasing shares of that company. They can be bought either directly from the fund itself or from brokers acting on behalf of the fund. How do we redeem shares? That's simple – we sell them back to the fund (they have to buy them).

Most funds are run by investment professionals and analysts who decide which securities to include in the fund. However, there are also some non-managed funds, usually based on an index such as the S&P 500 or Dow Jones. Such funds simply duplicate the holdings of the index, so there is no need for analyses.

How do they work? For example, if the Dow Jones goes up by 5%, the mutual fund based on that index will also rise by 5%. Surprisingly, non-managed funds usually perform better than their managed counterparts.

So far so good, but there are also a few downsides. First, there are fees that must be paid regardless of how the fund performs. Then, the individual investor has nothing to say about which securities should be included in the fund. Lastly, the current value of a mutual fund remains unknown until it publishes its financial statement (twice a year).

Mutual funds are a good choice for the smaller or part-time investors, better than either stocks or bonds. For one, they provide investors with the diversity that lessen the shock caused by sudden stock market movements while usually outperforming bonds. Of course, it is possible for a mutual funds to lose value, though mainly in the short term. Investors interested in short-term transactions should rather turn their attention to bonds which offer a set rate of return.

Money market funds, bond funds and stock funds are three main types of mutual funds currently on market. Money market funds offer the lowest risk, but also the lowest return rate. Their portfolios consist only of high quality investments – for example, bonds issued by the US government and blue chip corporations.

Bond funds usually produce higher profit than money market funds, but they are also a little more risky. The reason is simple: all the risks associated with bonds – bankruptcy or falling interest rates – can also damage bond funds.

Stock funds are mutual funds with the greatest potential, but also carry the most risk. However, they are dangerous mostly for the short-term holders – stocks usually outperform other investments in the long run. There are two main types of stock funds - 'growth funds' that aim to maximize the gain and 'income funds' that concentrate on stocks that pay regular dividends.

Mutual funds are ideal investment instruments for everyone with limited funds or none investment experience. The choice between the funds is a decision on how much risk you want to take against the expected return rate.

To find out more about learn stock investing and stock trading strategies visit http://www.learn-stock-investing.info