Mutual Funds Vs. Common Stock
Common stocks have been around since the dawn of organized trading exchanges, dating back to the late 18th century in the United States. Mutual funds, by contrast, are relatively new instruments, tracing their origin to the investment trusts of the 1920s. Many investors use a combination of mutual funds and common stocks in their portfolios, but some distinctly prefer one over the other.
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History
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In the United States, trading in shares of common stocks commenced shortly after the 1792 Buttonwood Agreement, which formed what is now known as the New York Stock Exchange. Mutual funds evolved out of investment trusts and similar pooled investment vehicles of the early 20th century. After the 1929 stock market crash, all public funds were forced to register with the newly created Securities and Exchange Commission (SEC), and later on follow the guidelines of the 1940 Investment Company Act.
Definition
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Common stocks are the equity securities corporations make available to the public to help finance their operations. Mutual funds are investment entities operated by professional money managers that make a variety of investments, oftentimes in common stocks, and pass on their earnings or capital gains to their investors. Fund management derives earnings for themselves by way of a variety of front-end, back-end, or other administrative fees, together with performance incentives for generating positive investment returns, typically in excess of a benchmark like the S&P 500.
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Investor Suitability
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Investing in mutual funds is generally considered more appropriate for passive investors who wish to have a professional manage their investments for them. Common stock investing is more appropriate for hands-on investors who want to control their own destiny. Some common stock investors feel that since mutual funds are basically proxies for common stock ownership, it's best to eliminate the middleman and all his fees, and take a do-it-yourself approach.
Risk
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Common stocks and mutual funds expose investors to similar risks. In general, it's assumed that mutual funds are a bit safer because they spread their risk across a supposedly diversified portfolio of at least several dozen stocks. One stock going bankrupt should not cripple a mutual fund, whereas if an investor had used all his investment capital on that stock, he would be out of money. In practice, actively managed mutual funds have often struggled to outperform benchmark indexes like the S&P 500 in bullish years, and often fall as hard or harder in bear markets, when most stocks tend to sell-off with equal intensity. A disciplined investor who knows how to manage his risk proficiently would probably not expose himself to any greater risk in common stocks than he would in a mutual fund.
Key Personalities
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Two of the more famous mutual fund industry stalwarts are John Bogle and Peter Lynch. Bogle's Vanguard Group company revolutionized the industry by providing the public with no-load index funds, which used investor capital to simply track an index like the S&P 500, rather than have managers attempt to pick stocks themselves. Their no-load fee structure also made them far cheaper than competing actively managed mutual funds. Peter Lynch had a successful career as a mutual fund manager for Fidelity Investments, including oversight of the multi-billion dollar Magellan Fund. He became popular through a series of articles and books extolling the investment philosophy of local knowledge, or investing in what you know.
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References
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