Are Mutual Funds Considered Equity Securities?

Mutual funds are investment vehicles that purchase stocks with investor capital in the hopes of capital appreciation. They are considered equity securities because investors purchase mutual fund shares, which represent ownership in the fund, giving them access to equity securities.

Shareholders, however, do not own the underlying assets (the stocks) but just a piece of the fund’s overall portfolio. By participating in a mutual fund, investors benefit from diversification and professional management and are considered equity investors.

Key Takeaways

• Mutual funds allow investors to pool their capital and gain exposure to a mix of stocks, benefiting from diversification and professional management.
• Unlike buying individual stocks, mutual fund investors own shares of the fund, not the underlying asset; however, they are still considered equity investors.
• Mutual fund investors benefit from capital appreciation and dividend payouts just as investors holding individual stocks do.

Equity Securities

An equity security is any investment vehicle in which each investor is a part owner of the controlling company. If an individual investor purchases 10 out of a total of 100 shares in a given equity security, they own 10% of the venture and are entitled to 10% of its net profit in the event of liquidation.

Investing in equity securities also grants the investor various rights to participate in the running of the company and may generate regular income in the form of dividends.

The most commonly traded equity securities are ordinary shares of stock bought and sold daily on the stock market. When an investor purchases a share of a company’s stock, they own a small piece of the company.

Note

An alternative to mutual funds is exchange-traded funds (ETFs). ETFs offer equity exposure and are often easier to manage as they can be bought and sold daily on exchanges like traditional stocks.

Mutual Funds

The difference between investing in stocks and investing in mutual funds is like the difference between selling your car to make a couple of bucks and buying a car dealership with 10 of your closest friends.

If you simply buy and sell your own car, you get to keep all the proceeds for yourself. However, you may not turn much of a profit if you cannot afford to buy a high-end car in the first place.

If you buy a car dealership as a group, you can leverage the sum of all your funds to invest in something that can generate a much larger profit. Though you have to split the proceeds, you can use your collective investment to sell a broader range of products.

Similarly, mutual funds are simply companies that allow many investors to leverage their combined funds to produce greater gains all around. Individuals purchase shares of the fund, which uses that money to invest in a diverse range of stocks, bonds, Treasury bills, or other highly liquid assets.

Shareholders are entitled to a portion of the profits commensurate with their financial interest in the fund. However, shareholders must avoid wash sales and other unethical practices.

What Is the Difference Between a Mutual Fund and a Stock?

A stock represents ownership in a single company. When you buy a stock, you’re buying a part of that company and your share comes with some features, such as voting rights. A mutual fund is a collection of investments, such as stocks, bonds, or other assets. When you buy a mutual fund, you’re buying a share in the fund, not the underlying asset (stock, bond, etc.).

With a stock, you have exposure to that one company, with a mutual fund, your investment is spread out over multiple stocks (in an equity mutual fund), which increases diversification, reducing risk. Additionally, mutual funds are professionally managed and choose stocks based on a theme, removing the work that you’d have to do in picking a stock.

Is an ETF a Mutual Fund?

No, an exchange-traded fund (ETF) is not a mutual fund. While both an ETF and a mutual fund are investment vehicles where investors pool capital to invest in a variety of securities, there are significant differences. ETFs trade on an exchange like stocks, so you can buy and sell them throughout the day at market prices. Mutual funds do not trade on exchanges and their prices are determined at the end of the trading day.

Additionally, ETFs are usually more affordable than mutual funds because they generally have lower expense ratios. Mutual funds also often come with minimum investment amounts, whereas with ETFs you can buy as little as one share, making them a less capital-intensive investment.

What Is One Example of an Equity Security?

An equity security is simply equity ownership of a company, meaning you own a portion of a company. This most commonly translates to the stock of a company. When private companies need to raise money, they go public through an initial public offering (IPO), offering shares to the public. These shares represent ownership in that company. An investor can buy that share (stock) and they now have an equity security. For example, if you bought Apple stock, you would have an equity security.

The Bottom Line

Mutual funds allow investors an easy way to gain access to a broad swath of equity securities without having to analyze and choose each stock on its own.

While shareholders don’t own the underlying stocks, and thereby do not have some traditional shareholder privileges, such as voting rights, the benefits of diversification and professional management often outweigh some of the drawbacks.