Stocks vs Mutual funds
As a new investor lot of people are struggling with this question. This includes me as well. When I started understanding the concept and importance of Investment, I was not able to take a decision on whether I should invest directly in the stock market or mutual funds.
Let’s understand both the investment avenues before we compare them for better returns.
In simple terms, stock or share or equity is the portion of ownership in the company. It means when. you buy 100 shares of any company you are actually buying a stake in that company. You can buy or sell stocks of the listed companies on a stock market where buyers and sellers decide the price at which they are willing to buy or sell the particular share. In our school days, if you remember we have learnt the concept of supply and demand in economics. The same rule of supply and demand works here in the stock market for deciding the price of the stock.
It is a system that accumulates money from thousands of people and invests that money in the financial market with the aim of generating good returns which they are giving back to the investors in mutual funds. Of course, they deduct some portion of the profit as their margin. Each mutual fund will have its own investment objective and theme. The fund managers can only invest accumulated money within the confined space of its objectives and theme. So by knowing the objective of the mutual fund scheme, we can decide whether it’s a good scheme or not. We can even predict the future returns on the basis of the objective of the theme. The broad types of the mutual funds are equity, debt, hybrid, diversified, money market etc.
There is a fund manager who manages the mutual fund scheme who decides where and when to invest in the market. Needless to say, these people are qualified experts who can make investment decisions on behalf of the people who have invested in that scheme.
Since we are comparing stocks and mutual funds, I am considering mutual funds as equity mutual funds as debt and liquid funds are completely a different asset class and hence cannot be compared with direct stocks.
Stocks vs Mutual Funds
As now you are aware of both the investment avenues, let’s compare them to find out which one is best. Like other real-world problem, the answer is not going to be simple and easy. It depends on the individual and differs person to person. Both stocks and mutual funds have their own pros and cons. Let’s compare them with the critical criteria.
# 1. Risk
As you know investing in stocks directly or indirectly through the route of mutual funds carry a risk. Sometimes its more important to save your capital than getting a return on your investment. Investing in mutual funds is less risky than investing in direct stocks. The main reason behind lesser risk is diversification. In a single mutual funds scheme, your money gets allocated to a large number of stocks. Thus reduces the risk of losing money even if something goes wrong in the market. The other factor for lesser risk is the fund managers. They are the people who are highly qualified and manages your money professionally. After all, that is their job and they are paid for it.
A lot of retail investors who invest directly in stocks are making losses as they are not able to manage their risk and devote their time to build strong, well-diversified portfolio. So the first point goes to Mutual Funds.
Score : Stocks – 0, Mutual funds – 1
# 2. Returns
We are here to make profits out of our investment. So when we are talking about investing, it’s certainly about making more money. Most of the actively managed mutual funds are not able to provide higher returns than the benchmark index over the long term. You would love to hear that top 10 mutual funds are giving higher returns than average funds. So your strategy should be to invest in top 2-3 funds in order to beat the market. The bad news is this strategy is not constant. It means it’s not certain that the top 2-3 fund will continuously outperform the market.
You can invest in the well researched diversified stocks that will provide you with the better returns than benchmark returns over a long term. This goes in favour of Stocks, so one point to stocks.
Score : Stocks – 1, Mutual Funds – 1
# 3. Cost
This goes directly in favour of direct stocks. In direct stock purchasing, you have to pay the only brokerage for buying and selling. The brokerage ranges from 0.5% to 1%. Nowadays there are many discount broker who offers zero brokerage or flat brokerage as low as Rs. 10 to Rs. 20. On the other hand, the mutual funds charge hefty brokerage of 2% to 3% per annum.Yes! you read it right. per annum. The brokerage you pay on mutual funds is recurring every year. It may seem a smaller number but over a long run, the fees can accumulate into a huge amount.
Score : Stocks – 2, Mutual Funds – 1
# 4. Ease of Investment
At a glance, investing in mutual funds is very easy. You just have to find the best 2-3 funds and allocate your investment amount equally and that’s it. You are done. you can even put your investment into auto-pilot mode by setting up a SIP at the regular intervals. The hard part is to find the best 2-3 funds out of a bunch of schemes available in the market. Of course, investing in stock is not a catwalk. As I mentioned earlier most of the retail investors are not able to spare time and resources required to research good stocks. 1 point to the mutual fund.
Score : Stocks -2, Mutual Funds – 2
To summarize, stocks have an ability to outperform mutual funds performance, the risk in both direct stocks and mutual funds can be managed well. The cost of investment in direct stocks is much lower than mutual funds. But in ease of investment, mutual funds win.
Mutual funds help you earn 14%-15% returns in a long-term, whereas if you really want to be rich you need 30% -40% returns in. a year and for that you need to invest in direct stocks. I personally believe that by investing in a mutual fund you are not going to become crazy rich. A mutual fund is good enough to help you achieve your financial goals and at some points financially independent which itself is a great thing. But if you want to become really rich, a mutual fund is not going to help you.
Investing in stocks is also not going to make you rich until you make it your profession. To earn 30%-40% returns in direct stocks, you need to really work hard. If you check the billionaires by investing are people who made investing their profession and passion. They have devoted their lives to it.
So go on, learn how to invest, read books, attain seminars, share your thoughts with like-minded people, start small but be consistent.