Each investment vehicle has its advantages and disadvantages. Read on to find out whether a brokerage account or a mutual fund is the best option for you, or if you may need to combine them.
To choose between brokerage accounts and mutual funds, the first step is to learn their main similarities and differences before investing.
What are mutual funds and brokerage accounts?
A mutual fund is a pooled investment security that combines assets of multiple investors into one professionally managed portfolio. Mutual funds can invest in stocks, bonds, cash, or a combination of these assets.
A brokerage account is used by investors to buy, sell and hold investment securities, such as stocks and bonds. Ownership of brokerage accounts can be on an individual basis or they may be owned jointly.
Similarities between brokerage accounts and mutual funds
Although the nuances are subtle, investors should understand them before they invest.
Diversification and Flexibility: Brokerage accounts and mutual funds can provide broad diversification, which means that multiple security types can be held within each investment vehicle. However, the degree of diversification is up to the investor.
Taxation: Although taxation can vary slightly between brokerage accounts and mutual funds, there are key similarities: Interest and dividends are taxed as ordinary income and investors pay taxes on capital gains.
Professional Management: If purchased through a full-service brokerage firm, brokerage accounts can be professionally managed. Mutual funds are also professionally managed, although some are passively-managed funds, such as index funds.
Differences between brokerage accounts and mutual funds
These differences will be the main factors to take into account when deciding which is best for you.
Structure: Probably, the biggest difference between brokerage accounts and mutual funds is their purpose and functionality, which combine as the structure. Brokerage accounts are not investments; they are accounts that hold investments. And, although they do hold securities, mutual funds are not accounts. The investor will buy the mutual fund inside an account, which may be a brokerage account, an IRA, a 401(k), a variable annuity, or directly through a mutual fund company.
Opening costs: Brokerage accounts can be opened with no initial costs or fees to the investor, mutual funds, on the other hand, often have minimum initial investments.
Fees: Ongoing fees can be different in each case. For example, the fees for a brokerage account primarily consist of trading costs, such as transaction fees or commissions. Mutual funds can have sales charges, called loads. There are also no-load funds that do not have sales charges.
Now that you know what's what in brokerage accounts and mutual funds, you can decide what option fits your financial goals better.