Stocks vs Mutual Funds - Choose Your Right Investment Fit

With bank interest rates dwindling year on year and with every investor revelling in the equity market's raging bull run, more and more people are giving shares and mutual funds a whirl. Ironically though, plunging in without having done the groundwork of understanding these modes of investments is a precarious move. So if you have stopped to wonder which one would be the right choice for you, you have taken the first step just right. We are here to guide you on the rest.

Let us first get to the basics.

What are stocks/shares?

Stocks that you can buy and sell in the markets are part-ownership rights that you get in big listed companies. It is like you are contributing capital to these companies for their operations, only instead of loan you are participating as an equity holder. Unlike loans or debentures where there are assured interest payments, here you are exposed to the uncertainty in returns as it all depends upon how the company performs. 

And a Mutual Fund?

Well, you can imagine it as a large pool of money from thousands of retail investors that are then invested by experts (known as fund managers) in several hundred stocks or more. So when you buy a unit of the mutual fund, you are buying a proportionate share of that entire asset class maintained by the fund house. So in a way, you again become part-owner of all those companies that the fund has invested in.

In either case, you are participating as an equity investor, and you bear the risks and rewards that those shares are exposed to. Even then, they largely vary in terms of some features, and you can decide which is more suitable for you based on certain factors and  parameters:

Diversification

When you are buying a particular stock or a few stocks, you are betting all your money on those few stocks only. There is little to no diversification, and here, you can either earn a lot of profits or end up in losses which exposes you to a lot of volatility. It is true you can cut that risk down if you can ably invest in multiple stocks and diversify your portfolio yourself.

Mutual Funds invest in a huge number of companies across various sectors that have negative correlations, to dilute the risk and optimise the returns. Such a huge level of diversification can rarely be achieved by an individual investor.

Active or Passive Investment Approach

If you are someone who can actively track, rebalance and shuffle your investments, direct stocks can give you higher returns when it is done in a disciplined and systematic manner. But if you cannot afford to invest so much time in researching and managing your portfolio, you should invest in a mutual fund and leave the rest to the experts. Then all you need to do track is your fund's average returns once in a while to avoid losing out on better opportunities.

Risk-Return Tradeoff

With very high growth stocks, you can time the market and get high returns in a short period. The downside is that the risk of the prices going down is equally high.

Mutual Funds have historically given great returns too, but more in the long run, as intense diversification mutes both the risks and returns in the short term.

Investment Amount

Even large-cap mutual funds have NAVs that are affordable for small investors just starting out. But most large-cap and blue-chip shares are relatively expensive, so you cannot diversify well if your investment amount is not sufficient. So if you are a new investor and are considerably risk-averse, a mutual fund might be the right place to begin.

Autonomy Vs Expert knowledge

The funds are managed by experienced fund managers who are well versed with the way of the market. While their rich expertise is an add-on to the other benefits, indeed, here, you do not have any autonomy to choose when and where to invest or divest.

If you are investing, holding and selling stocks yourself, you can have absolute freedom of decision. This is, of course, something that you would like to have if you have the skill and knowledge to gauge the market movements and economic cues.

Expenses

Since the fund is managing your money by employing expert managers and incurring administration expenses, it is going to charge a commission/consideration from you. An expense ratio is expressed and charged as a percentage of assets managed by that fund.

In direct stock trading, however, you will only have to pay nominal brokerages when you buy and sell. 

Time Horizon

As we discussed earlier, it is possible to earn quick money in very high growth stocks if you are willing to bear a high risk. So if you are looking to achieve a financial goal in the short term, direct stocks might be worth the risk. Nonetheless, value stocks can also give you returns in the longer term.

In mutual fund investment, the returns start to swell only when you stay invested beyond 5-7 years. Equity stocks may give you higher returns in a shorter period but rarely earlier than 3 years.

Tax Savings

In terms of taxation of gains, both stocks and mutual funds enjoy a similar stance. There is no tax benefit in terms of deduction if you invest in direct equities, but ELSS Mutual Funds can save you taxes as they are eligible for deduction under section 80C of the Income Tax Act.

As you can see, both modes of investments have their innate pros and cons, and it is your outlook as an investor that largely matters when making the final choice. But hey, it's not all black and white when it comes to investing, so you can allocate your funds in a ratio that suits your profile and enjoy the best of both worlds.