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Choosing between funds & individual securities

Start by diversifying your portfolio with mutual funds or ETFs. If you want, you can also fill out your portfolio using individual securities.

POINTS TO KNOW

  • Investing in mutual funds or ETFs is easier and less risky than investing in individual securities.
  • You can complement the mutual funds or ETFs in your portfolio with specific stocks and bonds.

Funds or individual securities: Why does it matter?

Choosing specific stocks and bonds can be the most intimidating part of investing. How do you find the most promising investments? What if you're wrong—will you lose everything?

Fortunately, there's a solution to this problem: Buy mutual funds or ETFs (exchange-traded funds) instead.

Both kinds of funds:

  • Hold hundreds or thousands of stocks, bonds, or both, so you don't have to bet everything on one company.
  • Are professionally managed, so you don't have to research each investment.
  • Cost much less than paying commissions to buy hundreds of individual securities.
  • Allow you to build a diversified portfolio even if you don't have hundreds of thousands of dollars to invest.

How do mutual funds and ETFs work?

Mutual funds and ETFs are very similar, but they trade differently. Both types of funds either buy all the stocks or bonds in a specific index (or at least a representative sample), or are run by a professional manager who actively chooses which stocks or bonds to buy based on research.

Either way, buying shares of a fund is a way to indirectly own the stocks or bonds owned by the fund.

For example, if you wanted to own stock in a company like Apple, you could buy Apple stock directly (although it could be a bit pricey). Or you could buy a mutual fund or ETF that owns Apple stock along with hundreds of other companies too.

Choosing your mutual funds or ETFs

No matter how involved you want to be in managing your portfolio, what segment of the market you want to invest in, or what type of investment strategy you want to follow, there are funds for you. Here's how to decide what to buy.

Adding individual securities

While we believe that everyone is best-served by taking advantage of the diversification offered by mutual funds and ETFs, there could be a place for individual stocks and bonds in your portfolio as well.


WATCH AND LEARN

Why invest in bonds through a fund? See how bond funds can offer benefits that go beyond diversification: the ability to get the best prices and better liquidity.

Individual bonds vs. bond funds Stream video

Read a transcript


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REFERENCE CONTENT

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Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

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Mutual fund

A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

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ETF (exchange-traded fund)

A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.

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Commission

A fee charged by a broker for executing a securities transaction.

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Diversification

The strategy of investing in multiple asset classes and among many securities in an attempt to lower overall investment risk.

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Portfolio

The sum total of your investments managed toward a specific goal.

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Index

An unmanaged group of securities whose overall performance is used as a benchmark. An index may be broad or focus on one sector or type of security.

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Share

A single unit of ownership in a mutual fund or an exchange-traded fund (ETF) or, for stocks, a corporation.

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Market

The trading of a universe of investments, based on factors like supply and demand. For example, the "stock market" refers to the trading of stocks.

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Individual bonds vs. bond funds

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Individual bonds vs. bond funds

Rebecca Katz: So, our next question in here is from Craig, and he says, "As a muni investor prepared to hold bonds until maturity, am I not better off owning bonds directly rather than through funds?" And we get this question a lot, whether it's muni bonds or just taxable bonds: "Should I just own a bond outright or own a fund?" And of course Vanguard offers both, you can buy both at Vanguard—so, let's answer in a very unbiased way.

Daniel Wallick: Sure, the way I think about that, Rebecca, is to think about, "Do you want to hold a single stock or a fund?" You can think of it the same way. There are pluses and minuses on both sides. The big challenge is when you hold a single security, whether it be a bond or a stock, you're taking more-concentrated risk. So that entity may do better than the broad diversified pool of bonds or worse.

And typically it can go either way, but you're potentially taking more risk. There's more variability in what the results can be.

Rebecca Katz: But in terms of the comparison between stocks and bonds, right, there's a big difference in the risk level of holding one's stock than a bond, right, because there's some implicit guarantees behind it?

Daniel Wallick: There may or may not be. So, the challenge with bonds is there's an asymmetric risk structure, and hopefully that word's not confusing.

Rebecca Katz: No, not at all.

Daniel Wallick: The point with asymmetry is with a bond, there's a limited amount of upside you can get, but you can go down to zero on the bottom end if you default. So taking more risk with bonds is actually challenging because there's a limited amount of additional benefit you can get from the increase in a bond.

Chris Alwine: And just to tag along on what Daniel was saying is that when you look at a portfolio of bonds, in some way it's like a mini mutual fund except it doesn't have the benefits and advantages of a large mutual fund around diversification that Daniel brought up. Execution efficiency. So, at Vanguard, we have an extensive trading desk looking to get best execution, trained experts, years of experience executing in the marketplace.

Rebecca Katz: And that marketplace is fairly opaque, right? Not like the stock market, where all of us can pretty much see what's going on with a stock price.

Chris Alwine: It's an over-the-counter market in terms of relationships with dealers and understanding the valuation. Now, what's interesting about munis is they're somewhat of a complex security, believe it or not, because of the call structures and the dollar prices and tax laws, and the lower liquidity of the marketplace. So it's certainly a market where having trained experts trading securities is quite helpful.

And the last advantage of the fund is "liquidity," meaning that if there's a need to redeem fund shares to spend money on specific purposes, it's there, as opposed to having to go into the market and sell a bond that's subject to best execution or good execution in the marketplace.


All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.

This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.

© 2014 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.