I started investing in the stock market years ago, mostly through mutual funds. One day, when I checked my portfolio, I realized I needed to take a harder look at choosing between mutual funds vs dividend stocks. Here’s why I chose to focus on dividend stocks.
Why I originally chose mutual funds
Back when I turned 18 I tried investing in individual dividend stocks. Unfortunately I still had a lot to learn and mostly lost money on the investments even though I kept the shares for more than 10 years.
And for a few years I worked at a financial services company with a strict trading policy. For individual stocks, I had to transfer my shares to an account at my employer and ask permission before doing any trades. Mutual funds did not have the same rules so it was simply easier to buy mutual funds at that point.
And then one late December day, after a rather volatile stock market year, I looked at my holdings and was shocked to see the dividend and capital gain earnings were significantly down on my mutual funds. While my overall account had not changed much in total value, I received a fraction of the earnings compared to the year before.
Since I no longer worked for the financial services company, I decided it was time to make a change.
Looking at Mutual Funds vs Dividend Stocks
Mutual funds are portfolios of investment holdings (including individual stocks) that follow preset rules to determine:
- The types of investments in the portfolio (including types of companies)
- When to buy new investments (stocks, bonds, other funds, etc)
- When to sell those investments (maybe it’s based on a percent gain in value or loss in value)
The money in the portfolio is made up of money from different investors. This gives smaller investors, such as us, access to professionally managed portfolios and sometimes investments that we could not buy on our own.
With the professional management of the fund, there are professionals actively watching the portfolio, doing research, and making decisions on what are the best investments to hold at that point in time.
Dividend stocks are individual stock shares in a company where the company pays out (usually quarterly) a portion of its profits (or reservers) to the shareholders. By holding stock in individual companies you have control over what you buy and sell. This can be seen as more risky because you own doing the research and making the decisions. Typically you’ll own stock in fewer companies than a diversified mutual fund.
But what I realized when looking at the mutual funds vs dividend stocks, many of the mutual funds I owned held shares in the companies that I could buy shares in myself. There was also some overlap in the companies each mutual fund portfolio was holding, even though these mutual funds had different investment focuses.
The other issue with mutual funds I realized, is that I could be more tolerant of a buy-and-hold approach as opposed to the mutual fund looking at a more short term timeframe. That’s not to say I have to hold all the shares forever, but I don’t have to be as driven by stricter guidelines to sell during a stock market hiccup.
Deciding between Dividend Stocks vs Mutual Funds
Ultimately I decided to sell most of the mutual funds in my IRAs to focus on dividend stocks because I wanted control. And the account had grown enough that I could comfortably buy shares in more than a few companies. I could create a diversified portfolio, taking ideas from the mutual funds I was selling.
For the mutual funds that focused on investments I could not easily buy (such as federal bonds and municipal bonds), I decided to keep those as I wanted to continue to have that type of investment in my portfolio.
In my taxable accounts, I also kept my mutual funds because the tax headache from selling those would have been substantial. For any new investment purchases, I’ll focus on dividend stocks.
And one more thing, what about taxes?
One of the arguments I see when it comes to dividend stocks vs mutual funds is that you have to pay income tax on the dividend payments. Yes, that’s true. While I’m not a tax professional, you’ll notice the tax rates change depending on if the dividend is considered “qualified” or “ordinary”.
For the mutual funds I held in regular accounts (not IRAs), I still ended up paying taxes on the income from those. They reinvest the dividends and capital gains of me, but I still own tax on all of that. With dividend stocks, while I have to pay taxes on the dividends I usually buy and hold my shares so most years I don’t have taxable capital gains income.
Over to you. What have you decided about mutual funds and dividend stocks?
While it’s true I’m not an investment or tax professional, it also feels like that should not hold me back from making decisions about how I invest my money. And what works for me, may not work for you. We each need to setup our own guidelines, based on our risk tolerances to build a portfolio we’re comfortable with. What did you decide to do?
More Dividend Investing Ideas
- 3 things I wish I knew before I started dividend stock investing
- Using Dividend Snowball Investing to grow your investment portfolio and income
- How to build a monthly dividend portfolio for passive income
- Dividend Kings: What are they? Who is on the list?
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