While making an investment, the investor faces trouble choosing alternatives such as equity mutual funds or shares for investing his/her wealth. For investors, who have never invested in equity, it’s hard to know where to start. But everyone knows their two distinct ways of investing in equity. An individual has to choose stocks and purchase and sell them by himself/ herself. The other way is to invest via equity funds. The final goal is the same: to earn profit from the superior returns that equity investing offers. But, in terms of what you do, the two routes are absolutely different.
Unless you are an expert investor or are willing to invest in a considerable amount of time and effort needed to become one, it does not make sense to invest in equities directly. Therefore, for beginners, the choice is quite straightforward: you should invest via mutual funds. There are many who invest by themselves and get great results. But, in general, the odds are unfavorable.
What are Stocks?
Shares are considered as the physical representation of a tiny portion of a company’s value that is being traded in the stock market. In case a company goes public and issues shares, the total value of the shares of the company in the stock and/or owned by persons, comprises the combined value of the company. As a shareholder one owns a small part of the company and it means that one can take part in the annual shareholder meets.
What are Mutual Funds?
Mutual funds can be understood as a collection of stocks and bonds that are administered by fund managers in an Asset Management Company (AMC). In case it is an equity mutual fund, it will carry stocks, while debt mutual funds will carry government bonds and securities. For instance, DSP BlackRock Micro Cap Fund comprises stocks of 62 companies from various sectors, that includes Sun Pharma, Manappuram Finance, Finolex Cables, Somany Ceramics, DCB Bank, JK Lakshmi Cement, Siyaram Silk Mills, and Ashiana Housing.
Mutual fund investments are a form of investment in stocks and bonds. They are mainly managed by AMC or investment houses. On the contrary, direct investment in stocks, as well as shares, is an active form of investment. Here you will handle the purchase and sale of the products yourself. The mutual funds offer institutionalization which is good for a new investor. On the other hand, direct investment in shares is good for those who have knowledge about the market and can handle it themselves.
Differences Between Investment in Mutual Funds and Direct Investment in Stocks
Some of the key differences between investment in mutual funds and shares are discussed below:
- Shares are seen as a part of a business’s growth strategy. Mutual funds, on the other hand, are seen as investment options for individuals.
- While trading in shares you need to have a Demat account. Mutual fund investment does not require a Demat account, though, in case you have one, you can utilize it to manage mutual funds.
- As mutual funds are stocks portfolio of companies that are pre-determined and altered by a fund manager, the investor has merely any control over the actual choice or trade of stocks. You also cannot choose to leave 1 or 2 of the stocks from the portfolio.
- Mutual funds are usually managed by a fund manager in an AMC. This external nature of the portfolio management ensures that the involvement on the part of the investor is direct except at the time of choosing the fund. Due to such a setup, mutual funds ideal for a new investor who does not have enough knowledge about the stock market. On the contrary, investing directly in shares requires good knowledge of the stock market and company performances. It is much of a hands-on activity that involves quick market decisions and is much better for the stock traders who are experienced.
- The passive nature of mutual funds enables people with money to invest in it. Whereas in the case of direct investment, you will be needing more time and dedication.
- You can also make investments in mutual funds via a fixed monthly Systematic Investment Plan (SIP) because it is managed by a professional. You cannot directly make such a fixed investment in shares. It is because the prices fluctuate consistently and require personal attention and prompt trade decision.
- As mutual funds have a diversified portfolio, negative returns will be cushioned by other stocks that will be doing well. For instance, in case your portfolio has 35 stocks, out of which 3 are dropping even the slightest growth in the remaining 35 will prevent your total fund value from crashing. Direct investment in stocks does not provide you this protection. It makes your stocks volatile. Unless you are dealing with a considerable number of stocks at the same time, your money will be at high risk.
- Mutual funds relatively have a longer-term growth trajectory. It is going to give you good returns only after 5-7 years. Whereas shares can provide you fast returns in case you purchase at the correct time and choose high-growth stocks.
- In the case of Mutual Funds, you will be requiring to pay fund management fees, a front-end load upon initial purchase, a back-end load upon sale, charges of early redemption, etc. whereas in the case of direct investment in shares you will be needing to pay brokerage to the stockbroker.
- It is simpler to classify your portfolio using mutual funds – there are alternatives like hybrid funds. On the contrary, when dealing with shares, you might not be able to deal with a large portfolio yourself.
- Direct investment in shares may provide you tax benefits only under Section 80CCG. Whereas tax benefits on equity mutual funds might be claimed under Section 80CCG and 80C in case it is an Equity-Linked Savings Scheme (ELSS).
Whether you should invest in mutual funds or shares will depend on the knowledge and experience of the market you have and the amount of time you invest. Mutual funds are an instrument of great investment in case you are a dilettante and are looking forward to the steady growth of wealth. However, in case you are a stock market virtuoso and have sufficient time in hand, direct investment in shares will prove a better choice.
A More Riskier Option?
Mutual funds have the advantage of diminishing the risk factor by classifying a portfolio by investing in a huge number of stocks. Whereas stocks are vulnerable to the conditions of the market and the performance of one stock would not compensate for the other.
Therefore, the factor of risk will be very high in terms of stock.