There are a number of reasons why an individual may choose to buy mutual funds instead of individual stocks. The most common are that mutual funds offer diversification, convenience and lower costs.

Many experts agree that almost all of the advantages of stock portfolio diversification (the benefits derived from buying a number of different stocks of companies operating in dissimilar sectors) are fully realized when a portfolio holds around 20 stocks. At the point that a portfolio holds 20 stocks from 20 companies operating in different industries, almost all of the diversifiable risk associated with investing has been diversified away. The remaining risk is deemed to be systematic risk, or market-wide risk, which cannot be diversified away. Since most brokerage firms having a minimum share purchase requirement, it's hard for many investors to afford 20 different stocks.

A brokerage firm that imposes a minimum share buy of 100 shares requires investors to buy 100 shares of each stock they wish to purchase. If the average price of a share is $20, then investors buying through that brokerage firm are required to invest a minimum of $40,000 ($20/share*100 shares*20 different stocks). Most investors just don't have $40,000 sitting around to invest, so mutual funds allow investors to get the maximum benefits of diversification without having to meet any minimum required share purchases.

The convenience of mutual funds is undeniable and is surely one of the main reasons investors choose them to provide the equity portion of their portfolio, rather than buying individual shares themselves. Determining a portfolio's asset allocation, researching individual stocks to find companies well positioned for growth as well as keeping an eye on the markets is all very time consuming. People devote entire careers to the stock market, and many still end up losing on their investments. Though investing in a mutual fund is certainly no guarantee that your investments will increase in value over time, it's a way to avoid some of the complicated decision-making involved in investing in stocks.

Many mutual funds like a sector fund offer investors the chance to buy into a specific industry, or buy stocks with a specific growth strategy such as aggressive growth fund, or value investing in a value fund. People find that buying a few shares of a mutual fund that meets their basic investment criteria easier than finding out what the companies the fund invests in actually do, and if they are good quality investments. They'd prefer to leave the research and decision-making up to someone else.

Finally, the trading costs of buying and selling stocks are often prohibitively high for individual investors. So high-priced in fact, that gains made from the stock's price appreciation can easily be canceled out by the costs of completing a single sale of an investor's shares of a given company. With a mutual fund, the cost of trades are spread over all investors in the fund, thereby lowering the cost per individual. Many brokerage firms make their money off of these trading costs, and the brokers working for them are encouraged to trade their clients' shares on a regular basis. Though the advice given by a broker may help clients make wise investment decisions, many investors find that the financial benefit of having a broker just doesn't justify the costs.

It's important to remember there's disadvantages of mutual fund investment as well, so as with any decision, educating yourself and learning about the bulk of available options is the best way to proceed.

(For further reading, see Advantages Of Mutual Funds, Disadvantages Of Mutual Funds and How Does Someone Actually Transact Securities?)

  1. Are mutual funds better than single stocks?

    Mutual funds offer advantages over individual stocks, including diversification and convenience. Investing in only a handful ... Read Full Answer >>
  2. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Does OptionsHouse have mutual funds?

    OptionsHouse has access to some mutual funds, but it depends on the fund in which the investor is looking to buy shares. ... Read Full Answer >>
  5. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  6. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    The Democratization of the Hedge Fund Industry

    The coveted compensations of hedge fund managers are protected by barriers of entry to the industry, but one recent startup is working to break those barriers.
  2. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  3. Professionals

    A Day in the Life of a Hedge Fund Manager

    Learn what a typical early morning to late evening workday for a hedge fund manager consists of and looks like from beginning to end.
  4. Stock Analysis

    Why did Wal-Mart's Stock Take a Fall in 2015?

    Wal-Mart is the largest company in the world, with a sterling track-record of profits and dividends. So why has its stock fallen sharply in 2015?
  5. Investing News

    Should You Invest in Disney Stock Before Star Wars?

    The force is strong with Disney stock, as it continues to make gains going into the launch of EP7. But is this pricey stock a good buy at these levels?
  6. Investing News

    Silicon Valley Startups Fly into Space

    Space enthusiasts are in for an exciting time as Silicon Valley startups take on the lucrative but expensive final frontier.
  7. Mutual Funds & ETFs

    American Funds' Top Funds for Retirement

    Planning for retirement in this economic and investment environment is far from easy. American Funds might offer an answer.
  8. Credit & Loans

    Pre-Qualified Vs. Pre-Approved - What's The Difference?

    These terms may sound the same, but they mean very different things for homebuyers.
  9. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  10. Investing Basics

    5 Tips For Diversifying Your Portfolio

    A diversified portfolio will protect you in a tough market. Get some solid tips here!
  1. Crude Oil

    Crude oil is a naturally occurring, unrefined petroleum product ...
  2. Leg

    A leg is one component of a derivatives trading strategy, in ...
  3. Benchmark

    A standard against which the performance of a security, mutual ...
  4. Grant

    The issuance of an award, such as a stock option, to key employees ...
  5. Put-Call Parity

    A principle that defines the relationship between the price of ...
  6. Equity Risk Premium

    The excess return that investing in the stock market provides ...

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center