When it comes to investing, one of the key decisions you may face is choosing between a brokerage account vs mutual fund. Both offer pathways to growing your wealth, but they work in different ways and cater to different types of investors.
Let’s dive into what each option entails, its pros and cons, and how to determine which might be the best fit for you.
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What is a brokerage account?
A brokerage account is a type of investment account that allows you to buy and sell a variety of securities, including stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Essentially, it’s your gateway to the stock market. You can open a brokerage account with a financial institution or an online brokerage firm.
Pros
- Control: You have full control over your investment strategy, deciding exactly what and when to buy, sell, and hold.
- Variety: You have access to a wide range of investment options, including stocks, bonds, ETFs, and more.
- Potential for high returns: With the right strategy, a brokerage account can offer significant growth.
Cons
- Time and knowledge required: Managing a brokerage account requires a very good understanding of the market and the proper time to monitor your investments.
- Risk: With greater control comes greater risk, as your investments can fluctuate widely in value.
- Fees: Depending on the brokerage, there may be trading fees or commissions, though many online brokers now offer commission-free trading.
What is a mutual fund?
A mutual fund is an investment vehicle that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. Think of it as a giant investment salad, and you buy a portion of it. The fund is managed by a professional portfolio manager who makes decisions about how to allocate the assets in the fund to achieve its objectives.
Pros
- Diversification: It reduces risk by spreading your investment across a wide range of assets.
- Professional management: With a mutual fund, an expert makes decisions on your behalf.
- Convenience: It's easier for investors who prefer a hands-off approach.
Cons
- Fees: Mutual funds typically charge management fees and sometimes additional costs like load fees to pay the professional working for you.
- Less control: You have little say in the investment decisions.
- Potential for lower returns: While it’s generally considered a safer way to invest, mutual fund returns may be lower compared to a well-managed brokerage account.
Brokerage account vs mutual fund: What are the differences?
So, what is the difference between a fund and a broker? The main distinction lies in who manages the investments and the level of control you have. But there are other factors to consider as well. Here’s a breakdown of their key contrasts:
- In a brokerage account, you’re the decision-maker. In a mutual fund, a professional manager decides how the money is invested.
- Mutual funds automatically provide diversification, while in a brokerage account, diversification depends on how you choose to allocate your investments.
- Brokerage accounts may have trading fees but no management fees, whereas mutual funds typically come with management fees and possibly other charges.
- Brokerage accounts can offer higher returns but also come with higher risks. Mutual funds tend to be more stable but might offer lower returns.
Despite these differences, “the central similarity between the two is that their ultimate purpose is to increase your wealth over time,” says Abid Salahi, a finance expert at FinlyWealth.
Mutual fund account vs brokerage account: How to choose the best option for you?
Choosing between a mutual fund account and a brokerage account depends on your investment goals, risk tolerance, and desired level of involvement.
When to choose a brokerage account
If you’re a hands-on investor with a good understanding of the market and a higher risk tolerance, a brokerage account might be the best choice. It allows you to actively manage your investments and potentially earn higher returns.
When to choose a mutual fund
If you prefer a hands-off approach and want the benefit of professional management with lower risk, a mutual fund could be more suitable. It offers diversification and stability, making it a good option for long-term, more conservative investors.
“Most mutual funds are more suitable for income generation and capital preservation, especially for the risk-averse investor nearing retirement,” Salahi says. “Professional management and built-in diversification may help guard against large losses in bad times.”
Why choose a combination of both
Both brokerage accounts and mutual funds have their strengths and can be valuable tools in your investment strategy. “I've advised clients to use mutual funds to build their foundation, then add a brokerage account once they’re confident, to be more hands-on,” says John Pace, a Certified Public Accountant with over 40 years of experience.
Salahi explains the balance: “The mutual funds would be invested in the core positions and broad market exposure, while the brokerage account is meant for the satellite positions in individual securities or sectors.”
Whatever investment choices you make, the key is to assess your personal financial goals, risk tolerance, and how much time you want to dedicate to managing your investments. By understanding the differences and evaluating your own needs, you can make an informed decision that will help you achieve your financial objectives.
FAQs
Is a brokerage account a good investment?
It depends on your financial goals and risk tolerance. A brokerage account offers the potential for high returns, especially if you have the knowledge and time to manage your investments actively. It gives you access to a wide range of investment options, from individual stocks to bonds and ETFs, allowing you to build a diversified portfolio.
“Opening a brokerage account allows you to adopt a sophisticated investment strategy,” Salahi says. “But investors must be ready to ride out market fluctuations and have significant time to devote to research and portfolio management.”
What is the biggest disadvantage of a brokerage account?
The biggest disadvantage of a brokerage account is the risk involved. Since you are responsible for managing your investments, the value of your portfolio can fluctuate significantly. This means you could experience substantial gains, but also losses, depending on market conditions.
Is it safe to keep more than $ 500,000 in a brokerage account?
Most brokerage accounts are insured by the Securities Investor Protection Corporation (SIPC), which covers losses of cash and securities up to $500,000 per account, including a $250,000 limit for cash.
However, SIPC insurance does not cover declines in the value of your investments. If you hold more than $500,000 in a brokerage account, consider spreading your assets across multiple accounts or firms to ensure full protection.
Is trading better than mutual funds?
Trading can potentially offer higher returns compared to mutual funds, but it also comes with higher risks and requires more time and knowledge. Mutual funds are designed for investors who prefer a hands-off approach and are seeking long-term, stable growth.
If you enjoy actively managing your investments and have the expertise to do so, trading might be for you. However, if you prefer a more conservative, low-maintenance investment, mutual funds could be a better option.
“Mutual funds are usually the better choice for new investors or those with little time,” Salahi says. “They provide professional management and instant diversification—especially important if you are still learning to invest.”
Is a mutual fund better than a brokerage account?
It depends on your investment style. If you prefer hands-on management and have the knowledge to navigate the markets, a brokerage account might be better. But if you prefer a more passive approach with professional management, a mutual fund could be the right choice.
Can I buy mutual funds in my brokerage account?
Yes, most brokerage accounts allow you to purchase mutual funds, giving you the best of both worlds—the flexibility of a brokerage account with the diversification of a mutual fund.
What is better than mutual funds?
ETFs may be considered a better alternative to mutual funds due to their lower fees, trading flexibility, and tax efficiency. Like mutual funds, ETFs offer diversification by holding a variety of assets.
However, they are traded like stocks on an exchange, which means you can buy and sell them throughout the trading day at market prices. This flexibility and cost-effectiveness make ETFs a popular choice among investors.