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If you’re considering investing your money, you may wonder whether to open a brokerage account or mutual fund. Both options can offer the potential for long-term capital gains, but they work in different ways.
A brokerage account lets you buy and sell individual stocks, bonds, crypto and other investments, such as real estate. A mutual fund pools money from multiple investors to buy a diversified portfolio of assets with high rankings.
Choosing the right option depends on your investment goals, risk tolerance and experience. In this article, we will explore the differences between a brokerage account and mutual fund and help you decide which one is right for you.
What is a Brokerage Account?
Brokerage accounts are investments that allow the purchasing and selling of various securities. Various financial institutions and initial public offerings, such as Fidelity, TD Ameritrade, and Vanguard, offer brokerage accounts.
You deposit money and then use the funds to purchase securities based on your financial goals and risk tolerance. You can also independently manage your account if you have enough knowledge and experience.
Many brokerage accounts also offer online trading platforms, allowing you to buy and sell securities from the comfort of your home from anywhere, including New York.
Advantages of Brokerage Accounts
Brokerage accounts have many advantages:
- Unlike retirement planning, there are no limits on how much you can contribute to a brokerage account.
- You can withdraw money from your brokerage account without penalty.
- Some brokerage accounts allow you to borrow money against the securities in your account.
Disadvantages of Brokerage Accounts
While there are many advantages, brokerage accounts have several downfalls:
- Unlike retirement accounts, such as IRAs and 401(k)s, brokerage accounts don’t offer tax advantages.
- When you sell a security for a profit, you’ll have to pay short-term capital gains taxes on the earnings.
- While some brokerage accounts offer access to financial advisors, this investment advice is often limited in scope and may come at an additional cost.
What is a Mutual Fund?
A mutual fund is an investment that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets. When you invest in a mutual fund, you’re buying a share of the fund’s overall portfolio.
Professional fund managers manage the accounts and make investment decisions on behalf of the investors. The goal of a mutual fund is to provide investors with a diversified asset portfolio without having to purchase individual stocks or bonds themselves.
The value of mutual fund shares is based on underlying assets held by the fund and can go up or down based on changes in the stock market value of those assets. Investors in a mutual fund earn returns in the form of capital gains and dividends that are generated by the fund’s holdings.
Mutual funds can be bought and sold through a brokerage account or a mutual fund company.
Advantages of Mutual Funds
The top mutual funds have the following advantages:
- Mutual funds allow you to invest in stocks, bonds or other assets, which can help reduce the risk of loss due to any one investment.
- These funds are often more cost-effective than buying individual securities since the costs of managing the fund are spread out among all the investors.
- Mutual funds are managed by professional fund managers who have the necessary knowledge and experience to make investment decisions on behalf of the investors.
- Because mutual funds diversify across many different types of investments, they reduce the overall portfolio risk.
Disadvantages of Mutual Funds
As with all things, mutual funds also have disadvantages:
- Mutual funds often charge annual fees to cover the trading costs of managing the fund. These management fees are a percentage of the fund’s assets under management, which is known as the expense ratio.
- When a mutual fund sells securities at a profit, it generates capital gains, which they give to the investors as capital gains distributions.
- Unlike individual stocks, which can be bought and sold throughout the trading day, mutual funds can only be bought or sold at the end of the trading day when the net asset value is calculated.
Mutual Funds vs. Brokerage Accounts: How do they compare?
Here’s a comparison chart for mutual funds vs. brokerage accounts.
|Mutual Funds||Brokerage Accounts|
|Diversification||No contribution limits|
|Professional management||Withdraw money anytime|
|Risk reduction||Lots of investment options|
|High expense ratios||Ability to borrow money|
Which is Better: Brokerage Account or Mutual Fund?
Whether a brokerage account or mutual fund is better depends on the individual investor’s financial goals, risk tolerance and experience level. Here are some recommendations based on different types of investors:
For novice investors:
- Mutual funds are generally more suitable for novice investors as they offer diversification and professional management. Novice investors may not have sufficient knowledge to select individual stocks or other types of securities.
For experienced investors:
- Experienced investors may prefer brokerage accounts, as they offer more control and flexibility. With a brokerage account, investors can select individual stocks, bonds, exchange-traded funds (ETFs), and other securities to build a custom portfolio.
For investors looking for passive income:
- Mutual funds are generally better for investors looking for passive income as they provide regular dividends or interest rate payments.
For investors looking for maximum returns:
- Brokerage accounts may be better for investors looking for maximum returns as they provide more flexibility to pursue higher risk and potentially higher reward investments.
Investors should consider opening an online brokerage account if they find themselves in the following situations:
- The person wants more control over their investments: With a brokerage account, investors have complete control over their investment decisions.
- They have the time and expertise to manage their investments: These types of accounts require investors to manage their own investments.
- They want to maximize returns: Brokerage accounts provide more flexibility to pursue higher risk and potentially higher reward investments.
If investors find themselves in the following categories, they should select a mutual fund:
- They want diversification: Mutual funds offer investors instant diversification by investing in a basket of different securities.
- They prefer a hands-off approach to investment: Mutual funds are managed by professional fund managers.
- They want low-cost investments: Mutual funds typically have lower expense ratios than brokerage accounts, which can result in significant cost savings over time.
Here are some frequently asked questions and answers about investing in brokerage accounts and mutual funds.
Can you invest in mutual funds inside your brokerage account?
Many brokerage firms offer clients access to various fund families with the Securities Investor Protection Corporation.
This means investors can use their brokerage account to invest in mutual funds alongside other securities, such as stocks, bonds, and ETFs.
What is a good expense ratio for a mutual fund?
Generally, a reasonable expense ratio for a mutual fund is below 1% per year. However, some low-cost index funds may have expense ratios below 0.1%.
What are the average yearly returns for a mutual fund?
Mutual funds provide investors with long-term investment growth, but they also come with risks.
On average, mutual funds have returned between 8%-10% annually over the past few decades, but this can vary significantly from year to year.