Which is better: mutual funds or stocks?

Almost any way you do it, we believe that investing is the right move for your long-term financial future. But which is better: buying mutual funds or stocks? Well, it depends on your investment goals. In general, however, be aware that only 20% of mutual fund managers manage to beat their benchmark index in a given five-year interval. And keep in mind that a great manager in one five-year interval may be a goat in another. So when should you consider a mutual fund? Here’s the basic answer: When you lack the time, temperament, or expertise to buy individual securities, or you have no other option.

When to consider a mutual fund

Consider putting your money to work in mutual funds:

  • When it is passively managed, seeking to emulate an index such as the Standard & Poor’s 500 Index. This strategy automatically places you in about the 20th percentile of managed mutual funds — and without regression to mean, because your fund is the mean.
  • When you want a specialist to invest for you. Examples: companies headquartered in Chile, or special securities like preferred stocks or convertible bonds.
  • When you want bonds. Bonds generally are complex, and can involve potentially nasty surprises for individual investors, such as early redemption clauses.
  • When you want to buy in small monthly amounts. Some mutual funds will allow you to invest as little as $50 per month.
  • When your 401(k) or other retirement savings account gives you no other choice.

(An alternative to a mutual fund is an exchange-traded fund, or ETF.)

When to consider stocks

Conversely, you should invest in stocks:

  • After you have done your homework on the company you are interested in.
  • When you are committed to being a long-term partner in the company; in fact, in a number of companies.
  • If you are emotionally prepared to lose money in the short term, more than you might have lost had you instead bought an index fund, and sometimes in significant amounts.
  • A rule of thumb: When you have enough to invest that you won’t pay more than 1% in commissions.

Helpful links:

— Answer provided by Fool member Paul Thomas

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