While making an investment in equities, novice investors face the dilemma of whether to invest in the stock market or in mutual funds. One common question that troubles them is the difference between investing in stock and mutual funds. It depends on the investor what kind of gains he is expecting and what amount he is willing to invest. Both mutual funds and stocks are beneficial in their own ways.
Before we get to the discussion about the differences, let’s first examine what stock and mutual fund investing really are.
Stock Market Investing
Ownership certificates of a company are known by the term stock. It depicts ownership in a company and projects a claim on a particular part of the earnings and assets of the company. Investing directly in the stock of the company is known as stock market investing. Here you can purchase the companies that are listed on the stock exchange with a desire to earn profits whenever the price of that stock goes up.
Usually, there exist two types of stocks- preferred and common. An individual holding preferred stock has no right to vote at meetings but he does have a higher claim on earnings and assets when compared to common stock where the individual has the right to vote and get dividends but earnings are negligible.
When we talk about sharing dividends, the preferred stockholders get them first, and then the common holders receive their dividend. If in case the company is liquidated, the preferred stockholders will be getting their shares first.
Mutual Fund Investing
Mutual funds can be understood as an intellectual source of income or the entrepreneurs of the near future. This is because mutual funds are quite profitable and safe when compared with stocks. Mutual funds invest in securities like bonds, shares, or assets and are made up of many funds collected from various investors.
They are managed and operated by fund managers who invest the capital and try to make capital gains and income for the investors who have invested the capital in the mutual funds. Every shareholder is part of the profit or loss of the fund amount that is being invested.
A mutual fund can be seen as a collective investment that pools together the capital money of a large number of investors to purchase securities like stocks, FDs, bonds, etc. the funds are directed in various securities, and performance is tracked by the changes in the total market capital of the fund can be calculated by adding up the performance of the principal investment.
Differences Between Mutual Fund And Stock
- Investment cost: Investing in mutual funds comes with a payment of different charges such as an expense ratio, load fee (entry load, exit load), etc. Considering the top mutual funds, the expense ratio can go up to 2.5-3%.
On the contrary. If you looking forward to investing in the stock market, you need to open your brokerage account (that includes charges of opening an account), and you need to pay some maintenance charges annually too. Moreover, there are several costs while making a transaction in stocks like brokerage, STT, stamp duty, etc.
Whenever you compare the charges involved in stock and mutual fund investing, you’ll find out that the costs of investing in stocks are relatively lower. This might be because the maintenance of mutual funds is kind of costly. It adds up to many expenses such as management fees, managers’/employees’ salaries, administration charges, operational charges, etc. On the other hand, when making an investment in stocks the most crucial burden is only the brokerage.
- Investment volatility: direct investing in stocks has high volatility as compared to mutual fund investing. It might be because whenever you invest in shares, you generally purchase 10-15 stocks.
On the contrary, mutual funds are made up of a diversified portfolio with its investments in various securities such as stocks, bonds, FDs, etc. even when we look at equity-based mutual funds, they too invest in at least 50-100 stocks. Due to this huge diversification, the volatility in the mutual funds is lower as compared to that of shares.
- Potential of return: stock market brings a higher potential of return. Most of the leading and successful investors in the world and in India itself have built their wealth by investing directly in the stock market. Warren Buffett, RK Damani, Rakesh JhunJhunwala, etc to list a few.
However, the stock market does not always bring good luck to its investors. In fact, the majority of people lose money in the stock market. Although the return factor is higher while investing in stocks, the risk factor is also very high.
On the contrary, the good ranked mutual funds have awarded decent consistent returns to their shareholders. Although the returns not very high when compared to stocks. But the returns from mutual funds will be enough to build massive wealth for an average person for a secure future.
- Tax saving: in case you invest in ELSS (Equity Linked Saving Scheme) in Mutual funds, you can enjoy a tax deduction up to Rs. 1.5 lakhs in a year according to section 80c of the income tax act.
When investing in mutual funds you do not have to pay tax in case the fund sells any stock from its portfolio till you are holding the fund. This can be seen as a benefit of investing in mutual funds.
On the contrary, when you are in a stock market, you will have to pay a tax while selling a stock, no matter what the scenario is there are no tax benefits as such while investing in the stock market. You will pay a tax of 15% on short-term capital gains and a tax of 10% on long-term capital gains.
- Monitoring: you will be requiring constant monitoring while investing in a stock market. This reason is that the stock market investment is a personal thing. Moreover, the share market would be needing high monitoring due to its high volatility. Only you would be responsible for monitoring the stock market.
On the contrary, in mutual funds, the fund managers are the ones who take care of the investments and make decisions regarding buying and selling. Therefore, if you are investing in mutual funds you don’t need to monitor your fund much frequently. But it is viable to have a look at your funds once a year to know if your fund’s performance is in line with your goals.
- SIP Investment: Systematic Investment Plan (SIP) is an option provided by mutual funds.
A SIP is a periodic investment. For example, a fixed amount can be invested by an investor, say Rs 1,000 or 5,000, every month (or quarterly or in six months) to buy some units of the fund. SIP helps with investing automation and it brings discipline to the investment strategy.
There is no such option in stock market investing, on the contrary.