General Question

f4a's avatar

In your own words, what are the difference between Mutal funds, bonds, and stocks?

Asked by f4a (601points) June 14th, 2009

What are the differences, similarities and definitions? Why is it more attractive to buy the other compare to the other two?

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9 Answers

juwhite1's avatar

Mutual funds are a collection of stocks managed by a company that charges fees. They allow you to diversify your portfolio when you don’t have a lot of money, but their fees tend to be very high compared with the earnings you could get if you just invested in, say, and ETF (spider) that is based on a large segment of the market (such as the S&P500). ETF’s are individual stocks that are comprised of several other stocks from a particular industry, index, etc. Bonds are basically a tool that can be used to raise capital by governments and other entities. You buy the bond, and they guarantee a set payment after a set period of time. Bonds are slow growing, and often don’t keep up with inflation, but are safe investments. Stocks are ownership in a particular company… for example, you can buy 100 shares of interest in General Electric.

dalepetrie's avatar

I’ll give you the real layman’s answer here.

Mutual funds are collections of different stock. The purpose of a mutual fund as I understand it is you can use it to maximize the profit and minimize the risk by having a diverse enough portfolio. Because any one stock or any small category of stocks, even if they are generally very profitable, can at times lose money. So a good investment person (the person who would put together the mutual fund) can use knowledge of business and how things are interrelated to make decisions….for example, in times when businesses which provide service x do poorly, usually businesses which provide service y tend to do well. Or (though this doesn’t seem to be true today, it was considered almost a fact for many years) when the US economy is down, foreign economies are up, so don’t put ALL your money in on country’s stocks. The other thing that kind of sets mutuals apart is that they are intended as pools of stocks from which people can buy really, small quantities, as opposed to stocks, where if you want to say buy IBM, you have to buy 1000 shares (or whatever the minimum buy in might be). So, if you have $50 a check to invest, you can invest it in a mutual fund which might have some IBM stock in it, but IBM’s stock is probably worth more than $50 for a single share, you wouldn’t even be able to buy one share, and since they would only sell you 1000 shares at a time, you couldn’t do it. Mutual funds pool the stocks, but they also pool plan participants, the broker will put together a mutual fund and shop it out to thousands of companies’ 401(k) plans and millions of people putting their $50 a check each into the fund makes the broker able to buy the minimum quantities of each of these shares. What makes this more attractive to people than bonds is that usually, a good mutual fund can provide a much higher return on investment than bonds, which pay a guaranteed interest rate but a fairly low one. What makes this more attractive than stocks is that a) the average person can invest in them and b) unlike a single stock, a mutual fund might mitigate the risks a bit, because even though it is made up of some of those same single stocks that went down in value, it might also partly be made up of single stocks that went up in value, bucking the trend. Generally your risk of losing all your money is far smaller than if you buy a single stock.

A bond is basically when some entity, often a government, wants to raise money, they will act kind of like a bank and say, you buy this bond for $100, in 1 year it will be worth $105 (5% interest). You KNOW that in one year, it will be worth $105, it won’t be worth $200 and it won’t be worth $25, whereas $100 invested in a stock or mutual fund COULD be worth $25 or $200 after a year…it’s a predictable, guaranteed source of money. But even my 5% example is pretty high, a lot of bonds pay less than 5% interest, you aren’t going to get rich investing in bonds. When you realize that because of inflation/increases in the cost of living, if you have a dollar in your wallet and you keep that dollar in your wallet for a year, that dollar would buy you what 97 cents would buy you today…you might need $1.03 in a year to buy what a dollar would buy you today, so basically buying a bond that pays 3% interest just basically makes your money keep up with inflation…most bonds are pretty much designed to keep up with inflation give or take a percent or two. The benefits to bonds over mutual funds is that there is NO risk that you will lose money and that’s the same benefit over stocks, that and the fact that you can buy a bond with far less money than you can buy a stock.

Now a stock is an individual investment. One share represents one piece of the company (the company may sell millions, even tens of millions of pieces of itself). If that company does well, the stock becomes more desirable, more people want to own it, and since there is no limit to how well a successful company can do, there’s no limit to how well a stock can do. If you were able to get together $5,000 to buy 1000 shares of stock in a small company at $5 a share, and that company became the next Microsoft or Google, your stock could make you a millionaire within a few years. Or the company could go bust and you could lose every penny. The benefit to stocks over bonds is that you can do significantly better, up to attaining obscene amounts of wealth with stocks, whereas bonds just barely keep pace with inflation. The benefit to stocks over mutual funds is that if you pick the right stock, the sky’s the limit, whereas in a mutual fund even if one or two stocks have great success. the rest will perform anywhere from modestly well to losing all their value, and when you average it out, there is no way that a successful mutual could come anywhere near the return of a successful stock.

The basic rule is, the more risk involved, the more opportunity for reward, and vice versa. Mutuals are often seen as the best investment tool for the masses via 401(k)s because even though there are fees involved that are hidden within the cost the investor sees, with a good mutual, care has been taken to mitigate the risks and maximize the rewards, they are accessible, and they represent a broader portion of the stock market as a whole, making it over time an almost guaranteed way to outpace inflation and build wealth modestly and slowly, but wealth nonetheless.

juwhite1's avatar

401(k)s are seen as a great investment option when the company matches the employee’s contribution, because the employee is getting free money in a tax sheltered account. While 401(k)s can and usually do contain mutual funds as some of their investment options, the two are not synonymous. I don’t know of any investment adviser, other than one peddling a mutual fund, who would recommend buying into mutual funds outside of 401(k)s, and have certainly never heard of them being seen as the best investment option. They are widely held as one of the worst investment options, but they are so easy for people who don’t understand how the market works and are certainly much better than not investing at all, so for some people, these may be the best option. I’d recommend educating ones self about the market, and especially looking into ETF’s, which accomplish all the same things as a mutual funds in terms of offering diversification and ease of investing, without the fees, then deciding which option is best for your particular situation. Likely, with just a little bit of self-education, you’ll find that mutual funds are not really the best option for you.

dalepetrie's avatar

They are the best investment option however for people who don’t know anything about stocks, that’s my point. Over time they almost always give a person more return on investment than a bond or savings or money market account would, but someone who understands the market can almost always do much better. But a 401(k) offers mutuals as one of many investment options….usually however 401(k)s don’t offer individual stocks (sometimes they offer bonds or money markets with guaranteed or close to guaranteed returns…though modest returns at best). If you are a good investor, and really know the market. Stocks are the superior way to build wealth, but they’re also the hardest to master. In my opinion, if you just want to put away some money for retirement and don’t want to learn the ins and outs of the stock market, the mutual probably IS the best option…it’s not the cheapest and its’ not the best return, but it’s a good happy medium fro those of us who are risk averse and have no desire to become stock traders.

juwhite1's avatar

Check into ETF’s… they basically are mutual funds, but without the fees. They are purchased as a stock, but you can buy the entire NASDAQ, Dow, or S&P 500, or you can pick from ETF’s that combine international stocks, buy all the shares in a certain segment or industry, etc. They are a relatively new investment tool, and are far superior in performance to mutual funds, with all the exact same advantages. You don’t have to know anything about investing, get automatic diversification, but don’t pay the fees that accompany mutual funds.

YARNLADY's avatar

In my words, a stock is when you buy an ownership piece of a company. If the company makes a profit, so do you.

A bond is when you loan money to a government or agency and they promise to pay it back with interest.

A mutual fund is when you let an investment use your money to invest in whatever stock, bond, or other investment they feel will earn you a return on your money.

We used to invest in mutual funds exclusively, before Hubby learned his way around the investment market, and now he handles all our stocks, bonds and other investments.

dalepetrie's avatar

If I ever have money again (been out of work since Feb), I’ll check out some ETFs

justin's avatar

While lower in fees, ETFs aren’t ‘managed’ like a mutual fund. Whether active management is worth the cost is one thing, but know that it is on you to do the managing if you are investing with ETFs.

RomanExpert's avatar

Stocks represent part ownership in a company. In general, you buy low and sell high (or sell high and buy low) for a profit. Bonds are essentially loans to companies and municipalities where you earn money through interest payments paid to you on an quarterly basis. Mutual funds are a collection of stocks which are managed by a fund manager (a chimpanzee and a dartboard can pick 20 stocks that are going to essentially break even). Depending on your age, invest and trade in stocks. Be self-directed! The difference between the investment products is risk/reward of course, the higher the risk, the higher the reward. Read “The Only Investment Guide You Will Ever Need” by Andrew Tobias.

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