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Mutual Funds vs. Stocks: Which Is Better for Your 401(k)?

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While many 401(k) plans do not allow the option to invest in individual stocks, there are some that do. If your 401(k) plan does give you the option to invest in individual stocks, it would be wise to consider the pros and cons of doing so. In this article we hope to provide assistance to 401(k) plan participants who have the option to invest in individual stocks.

The debate about Mutual Funds versus Stocks is nothing new. We would say both are winners. This win however depends on investment objectives. Focusing on 401(k) plan, or for retirement, we believe mutual funds are the clear winners. That stems from the fact that mutual funds offer better SIP investment option, asset class flexibility and expert fund management.  

Mutual funds are safer and probably the right solution for investors serious about retirement savings in the 401(k) plan. To gain the most from a 401(k) plan, fund diversification is crucial. Mutual funds have relatively larger asset class flexibility, i.e., unlike stocks all the money is not necessarily invested in the equity asset class.

Managed mutual funds come with the option of expert and professional fund management. In case of stocks, individual investors are often doubtful about the right stock picks. In the case of managed funds, fund managers will make the expert decision, helping investors enjoy gains.

The tax-qualified, defined-contribution pension account or 401(k) plan was introduced to help taxpayers benefit from a tax break while doing their retirement savings. Along with tax benefits, this plan comes with the perk of employers contributing money. The 401(k) plan offers investment in mutual funds among others. A study by Investment Company Institute had shown that 60% of the $3,565 billion dollars in the 401(k) plan assets belonged to mutual funds in 2012.

Mutual Funds Vs Stocks: Pros and Cons

As said, both mutual funds and stocks have their advantages. Depending on investment objective, stocks or mutual funds should be chosen. While we have already mentioned the characteristics that make mutual funds winner for 401(k) investments, let’s look into them in details and how other attributes make stocks or mutual funds special.

Tax: Be it stocks or mutual funds, taxes must be paid for both options. However for stocks, an investor may decide when to take losses or gains – given the plan comprises pro-active comprehensive tax & investment strategy. Portfolio management fee, if employed, is tax-deductible in case of stocks. However for mutual funds, management fees are not tax deductible. Moreover, an investor has no control over the amount of capital gains tax that must be paid.

Diversification: One of the benefits of mutual funds is that it allows a small investor to invest in a basket of securities at one go. Investors need not worry about investing a large chunk in securities separately. Moreover, these are less risky than any individual asset class as underperformance of a security gets mitigated by outperformance of others in the portfolio. Unlike stocks, investing in one mutual fund means investing in a basket of securities.

Professional Management: Only in case of the appointment of a portfolio manager can stock investments be professionally managed. However, that comes at a definite cost. In the case of mutual funds, management fees must be paid. However, there are number of funds with very low expense structure. Managed mutual funds score over stocks as they are professionally managed. Investors need not worry about the timing of stock picking and selling as the fund manager will usually know better. Fund managers may also employ various investment strategies to get the best returns from a Bull or Bear market.

Funds to Add to Your Portfolio

Mutual funds with a balanced asset allocation will provide under one roof, the three primary asset classes – stocks, bonds and cash equivalents.  Balanced funds provide investors with the convenience of buying into a single fund rather than holding both equity and bond funds. This category of funds also reduces a portfolio’s volatility while providing higher returns than pure fixed income investments. Fund managers of such funds also enjoy the flexibility of varying the proportion of equity and fixed income investments in response to market conditions. An upswing may prompt them to hold a relatively higher share of equity in order to maximize gains; whereas a downturn sees them turning to fixed income investments to stem losses.

Here we will suggest 3 Allocation Balanced mutual funds that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy).

Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

These funds have high 1, 3 and 5-year returns. The expense ratio is also low for these funds and they carry no sales load. The minimum initial investment for these funds is $5000.

Moreover, the manager rating for these funds is positive. It measures the risk-adjusted performance of a fund’s management relative to the fund’s peer group. This performance rating is based on the manager’s “value added” while with the fund; the number expressed represents the annualized percentage by which the actual return was above or below the “expected” return, with the expected return determined by the risk and performance of the peer group. (Read: Manager Ratings)

Schwab Balanced (SWOBX - Free Report) seeks income and capital appreciation. The fund invests in a mixed bag of Schwab and/or Laudus Funds. While 55-65% of the fund’s assets are invested in equities, 35-45% will be invested in fixed income securities, and cash and cash equivalents. A minimum of 25% of its assets will be invested in equities, and another up to 25% in fixed income securities. During unusual economic scenario, the fund may invest a maximum of 100% of its assets in cash, money market instruments, repurchase agreements and other short-term obligations.

SWOBX carries a Zacks Mutual Fund Rank #1 (Strong Buy). It has returned 9.4%, 10.9% and 10.6% over the last 1, 3 and 5-year periods.  The fund has an annual expense ratio of 0% as compared to category average of 0.94%. As for asset allocation, 59.8% is invested in stocks, 34.1% in bonds and 5.6% in cash. The manager rating is 2.9%.

Mairs & Power Balanced Investor’s (MAPOX - Free Report) objective is to provide shareholders with regular current income, the potential for capital appreciation and a moderate level of volatility by investing in a diversified list of securities including bonds, preferred stocks, common stocks and other securities convertible into common stock. The fund aims to provide current income yield of a minimum of 25% higher than that of the S&P 500 Index.

MAPOX carries a Zacks Mutual Fund Rank #1 (Strong Buy). It has returned 8.6%, 12.5% and 12.1% over the last 1, 3 and 5-year periods.  The fund has an annual expense ratio of 0.72% as compared to category average of 0.94%. As for asset allocation, 60.2% is invested in stocks, 35.6% in bonds and 3.8% in cash. The manager rating is 2.7%.

Janus Balanced T (JABAX - Free Report) seeks appreciation of capital, in line with capital preservation and balance by current income. The fund invests 35-65% of its assets in equities and the remainder in fixed-income securities and cash equivalents. A minimum of 25% of its assets will be invested in fixed-income senior securities. The fixed-income securities may comprise U.S. government obligations, mortgage-backed securities and other mortgage-related products, and short-term securities.

JABAX carries a Zacks Mutual Fund Rank #2 (Buy). It has returned 9.4%, 10.6% and 8.5% over the last 1, 3 and 5-year periods.  The fund has an annual expense ratio of 0.82% as compared to category average of 0.94%. As for asset allocation, 55.2% is invested in stocks, 38.3% in bonds and 1.1% in cash. The manager rating is 1.9%.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Learn more about the Zacks Mutual Fund Rank at www.zacks.com/funds/mutual-funds.




In-Depth Zacks Research for the Tickers Above


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Schwab Balanced Fund (SWOBX) - free report >>

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Janus Henderson Balanced T (JABAX) - free report >>

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