A routine question that pops up in almost every investor’s mind is, Should I invest in mutual funds or individual stocks?
This is a classic question but there is no definitive equation that derives the answer to this problem. Also, there’s nothing right or wrong when it comes to mutual fund investments or investing in the share market. Both of them have their own benefits and drawbacks.
In contrast to the famous commercial that says“Mutual Funds Sahi hai”, stock investors say “Individual Stocks bhi Sahi hai.” Therefore, let’s look at both sides of investing in either of these instruments and then try to decide which is more suitable for you.
What are the various ways to invest your money?
Equity and debt are two of the most common investment instruments when it comes to stock market investing. Equity as an asset class offers the highest returns when compared to other assets. Further, you can invest in equity through direct share investing, ETFs or Mutual funds. Apart from equity, there are other safer assets like commodities (gold), debt instruments (Fixed Deposits, Government bonds, etc) where you can invest and get decent returns. Among these instruments, direct share investing and Mutual Fund investing are two of the most widely utilized methods used by retail investors. Therefore let’s figure out which method is best when it comes to investing in equity.
Difference between Mutual Funds and Stocks
Even though the underlying asset in mutual funds is composed of equity shares. There are some fundamental differences between investing in direct shares and investing in mutual funds. Let’s look at some of the major differences between the two.
When investing in direct stocks, you are a part-owner of the business. You are entitled to voting rights and other benefits such as dividends, stock splits, bonus issues, etc. On the other hand, in a mutual fund, you do not get ownership rights in the business. You just own units of the mutual fund, and your benefits and rights are restricted to the mutual fund house.
Overall risk and return
Investing in individual stocks involves higher risk when compared to mutual funds. If a particular stock does not perform well, your overall return goes down. While mutual funds own numerous securities, therefore, if a particular stock does not perform well, other shares compensate for its underperformance.
Research and portfolio management
If you are investing directly in the share market, you need to carry out the fundamental and technical research by yourself and then select a stock. Your stock selection process might be restricted to your knowledge and the tools available to you. Whereas mutual fund houses have dedicated financial managers who are responsible to carry out extensive research and then execute the trades.
One of the major differences between investing in direct shares and mutual funds is diversification. Being a retail investor, you might have limited capital to allocate towards individual companies. As you cannot buy fractional shares in the Indian stock market. Your stock selection might be limited to the price of stocks. But this is not a problem when you are investing in mutual funds. In mutual funds, you can invest as low as Rs 100 and gain exposure in 10-20 stocks at the same time.
Cost and Control over investments
When you invest in shares, you have complete control on the buying and selling according to your will. But when you put money into mutual funds, you do not get total control of your investments. You cannot increase or decrease the exposure in a particular company or sell a particular stock when investing in a mutual fund. Additionally, there are extra charges associated with mutual funds in the form of expense ratios and exit loads. Whereas there are no charges when it comes to direct stock investing except the brokerage.
Mutual Funds or individual shares, which is best?
Now that you know the primary difference between mutual funds. Equity shares, you should have more clarity while picking one. But if you are still confused, the following points might help you to decide which one is best for you.
- If you are a Passive investor, mutual funds might be a better option for you. The reason is, you do not have to spend time analyzing companies and investing in them. Whereas Active investors can prefer investing in the share market as it provides total control over your investments and offers ownership rights.
- For retail investors who have a small capital, mutual funds might offer better diversification and safety when compared to direct share investing. If you want to invest Rs 1000 in shares, your options might be restricted to the stocks that are trading under Rs 1000. But if you are investing in mutual funds, you can gain exposure to a minimum of 20 companies with the same 1000 rupees.
- The overall returns when investing in the share market might be more than mutual funds. This is because a mutual fund divides your capital into 15-20 companies. And even if one or two companies provide extraordinary returns. The total gains are muted due to limited exposure towards the particular companies. But, if you can successfully pick high return investments in the share market, your overall portfolio can get extraordinary returns. Therefore, if you want to beat the benchmark index, investing directly in stocks is the way to achieve that.
What should you do?
Investing is not a ‘one size fits all‘ approach where everyone can typically invest in the same instrument without looking at the risk. There are multiple variables like risk appetite, overall investment skills, return expectation, etc that you should consider before selecting a specific instrument. You must also decide how much risk you can tolerate when looking for high-return investments. If you have limited skills but still demand higher returns on your capital. Then mutual funds might be best for you.
On the other hand, if you possess the necessary expertise and skills to manage your investments, are willing to bear the additional risk and also save the extra costs. In that case, investing in direct shares might be better for you.