Investing in Mutual Funds vs Direct Stocks - Which is a better option?
Where should you invest, Stocks or Mutual Funds? Which is riskier? What are the costs associated with them? Which is better?
A stock is a type of security that represents an ownership in the public company. When you are buying stocks of a company, you will be known as a shareholder.
A mutual fund is a professionally managed fund which pools the money from many investors and diversifies that money into securities like equity, government bonds, debt, gold and other asset classes as per the fund objective.
We have listed down a few points that need one’s attention as an investor on: How is investing in stocks different from investing in mutual funds?
- MANAGEMENT OF FUNDS
Mutual funds are managed by professional fund managers who have years of expertise and experience in the financial sector. Investing in the shares of a company requires a vast amount of research on the company’s fundamentals, its financials, corporate governance and some other important factors. If an individual investor makes an investment in a stock without spending time on its research, he/she may lose all their savings.
Mutual funds do all the extensive research and analysis on behalf of the investor and frees the investor from this complex part of investing.
Mutual funds carry the benefit of diversification as it becomes easy to diversify into different sectors and across different asset classes with even a small investment amount. Let’s say, you want to invest Rs.1000 in equities but with such a small amount it becomes difficult to take or buy units of different stocks, sectors. As it is said that an ideal portfolio should have at least 20-30 stocks, it becomes arduous for an investor to own those with limited money in hands.
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On the other hand, Mutual funds diversify their money into many stocks, bonds as per the scheme. With an investment in mutual funds, it can give you exposure to different companies, sectors and asset classes and ultimately can cover the losses arising out of some stocks with the profits in other stocks.
Investing in equity requires you to open a trading & demat account. Whereas, in mutual funds you don’t need to have a demat account. What you need to do is just KYC your documents online with the platform you want to invest through, then select the right funds according to your risk tolerance for your investment and invest in them. While investing directly in equities, one has to place orders for the different stocks that you wish to purchase. Therefore, it is easier to enter into mutual funds than investing in equities.
In equity investing, you have to pay for opening the trading account, annual maintenance fees and the brokerage fees for the purchase of securities along with the STT (Securities Transaction Tax).
Mutual funds charge a fee as expense ratio (the money which mutual funds spend as a percentage of their AUM in advertising, marketing, administrative fees). There are also brokerage fees but because of their large transactions they enjoy economies of scale.
Because of these reasons, mutual funds have far lesser costs compared to equities.
- TAXATION BENEFITS
Equity mutual funds are taxed similarly to equities, i.e 10% on Long term capital gains (gains over 1 year period) and 15% for Short Term Capital Gains (Below 1 year).
However, there is a particular category of funds known as Equity Linked Saving Schemes (ELSS) that invests in stocks. These funds have a lock-in period of 3 years and investments in these allow the investor a tax deductions up to an amount of Rs.1.5 lacs under Section 80C of the Income Tax Act, 1961.
- WHICH IS RISKIER?
Every investment product carries some risk with it. Investing in equity has the potential to give higher returns but carries a higher amount of risk.
Mutual funds are managed by experts and have schemes matching the risk profiles of different classes of investors. This only reduces the risk part for investors as they may invest in only those mutual funds which match their risk tolerance. However, while investing directly in equity everyone cannot measure the different risks that are carried by different investments.
So, Equity is certainly riskier to invest when compared with Mutual Funds.
If we talk about Equity, there is complete control on your investments. But in mutual funds, you don’t have control over the mutual fund portfolio and it is completely managed at the discretion of the fund manager. Only the fund manager can make decisions on adding or removing stocks from the fund.
In direct equity investment, you can choose from the various stocks in the market for investing.
In Mutual funds, there are over 3000 open-ended schemes available in the market to choose from and each fund has different risk/return characteristics as well as different objectives. An investor can make an investment in a fund according to their risk appetite and which is suitable to their needs.
One can invest in a mutual fund through Lump-sum or SIP (Systematic Investment Plan) SIP is a disciplined investing tool where one can invest a fixed amount at regular predefined periods, such as monthly. You can also invest a specific amount every month into equity, but that has two issues. For one, the investor needs to spend much more time on research. Second and more importantly, one tends to get indisciplined and hence misses out on the investment.
In conclusion, if you are an investor who does not have either the time or the know how to research various companies and to track them on a regular basis, mutual fund investing is better. As we have seen, investing in mutual funds has several other benefits when compared to investing directly in equities. However, if one has time, expertise & knowledge to research & analyse the stocks from time to time then he can go for direct equity investing.
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