Is it better for novice investors to purchase stocks directly or to use mutual funds instead? We examine the benefits and drawbacks of each in this blog so that you may make an informed choice whether you want to invest your hard-earned money in the stock market in order to reach your financial objectives or if you want to build wealth over the long run.
Stocks and Mutual Funds: A Basics Overview
We should begin by defining stocks and mutual funds.
Financial instruments called stocks are issued by businesses and allow investors to hold a portion of the firm. Aside from dividends and capital growth, investors put their excess money into stocks so they may vote and influence important business decisions.
In everyday speech, stocks are often referred to as shares and equities.Conversely, mutual funds are financial instruments that raise money from a large number of investors and invest it in various asset classes, such as equity, debt, gold, etc., depending on the fund’s investment goal. Mutual funds are professional organizations that provide professional fund management capabilities and a wide variety of fund options; in fact, there are three main types of funds: equity, debt, and hybrid funds; there are also solution-oriented funds, such as retirement funds and children’s funds, as well as other variations, such as index funds, exchange-traded funds, and Fund of Funds options.
Stocks or Mutual Funds: What should you pick?
Even though you can invest in stocks using either of these options, there are a number of reasons why you should choose a mutual fund. The top 7 reasons are as follows:
1. Diversification of the portfolio:
By investing in a wide range of stocks, mutual funds offer superior portfolio diversification and lower the risk of concentration. The portfolios of a sizable portion of the industry’s diversified funds contain at least 50 stocks.
In the event that one or two stocks are hit by unfavorable occurrences, this diversity helps to mitigate the portfolio’s losses. The risk component of the investments is further reduced by the fact that equity funds are only permitted to hold 10% of a given stock.
However, an investor’s stock portfolio typically consists of 10 to 15 stocks. Higher portfolio volatility results from this, and it will be put to the test when the market rises and falls.
Now, a substantial sum of money is required if you wish to have the same level of diversity as a mutual fund. There are expenses related to both purchasing and selling as well. For example, if you want to purchase one share of each of the NIFTY 50 elements, you will need more than Rs. 1 lakh.
Mutual funds offer investors the advantage of exposure to a wide range of stocks across market size and industries in their portfolio, even with a modest investment of Rs. 500.
2. Expert Administration:
A professional fund management staff that conducts extensive research on equities, industries, and the economy oversees mutual funds.
After deciding on the universe of stocks, this team spends a significant amount of time reviewing the companies’ financial statements and meeting with their management to gain a comprehensive understanding of the stocks that should be part of the portfolio. The majority of fund houses also have strong risk management procedures that impose strict contractual limitations, preventing the fund management team from taking excessive risks on their portfolios.
In contrast, investors will need to invest a significant amount of time in studying stocks and other industries in order to comprehend the underlying businesses headwinds and tailwinds. Direct stock traders should also have a solid understanding of the macroeconomic environment, as this will help them determine which industries and stocks will perform well in the future.
Investors must complete this crucial process because, depending on their risk tolerance, their portfolio of 10 to 15 stocks must be diversified across market capitalization and industries.
That is, the majority of the work done by the fund management team, which consists of risk modelers, technical analysts, economists, and fundamental analysts, must be done by the individual investor. In terms of time and effort, that is definitely not something that novice investors are interested in.
3. Cost Because buying and selling:
stocks involves such large transaction volumes, mutual funds benefit from economies of scale in terms of cost efficiency.
In 2013, SEBI also launched direct plans for the mutual fund sector. The fund houses deduct the commission payments to distributors from operating expenses under a direct plan build, which lowers the investor’s expense ratio.
To provide an example, the Kotak Flexi cap Funds’ expenditure ratio is 1.49% in the regular plan and 0.64% in the direct plan. You will receive better returns as a result of this 0.85% difference. A ~1% increase in returns is significant and can result in several lakhs of rupees more in wealth over time.
However, you would be responsible for paying fees such as brokerage, STT, SEBI turnover costs, GST, transaction charges, etc. if you purchase stocks directly. The good news is that these costs are typically little in the long term, unless you are trading equities on a daily basis.stocks and mutual funds
4. A Wide Range of Choices:
You have a lot of options when it comes to mutual funds to reach your financial objectives.
Different asset classes are served by different funds, such as foreign funds, debt funds, equities funds, and gold funds. Certain funds address particular objectives, such as retirement and child care plans. Other alternatives include active and passive funds. Depending on their time horizon and risk profile, you can choose from the available solutions.stocks and mutual funds
You can select from a range of debt funds with minimal exposure to large-cap equity funds if you have a conservative risk tolerance. However, if you are an ambitious investor, you can incorporate sector funds in your portfolio and even go over the market capitalization curve.
From a tenure standpoint, he can invest in liquid funds if his time horizon is between one and five months, while short-term/corporate bond funds will be a good choice if his time horizon is three years.
Mutual funds thus offer a range of funds according to investor risk profile, market capitalization, industries, goals, tenure, and risk-return expectations.stocks and mutual funds
There is just one asset class in the context of stock investing. Although there are often only 500 or so companies that are investable on Indian stock markets, there are, of course, over 5,000 companies to pick from within stocks.stocks and mutual funds
Mutual funds offer a wide range of options that give you many benefits that are not accessible when investing directly in stocks, such as debt exposure, diversification, and specific categories or funds to meet the goals.
5. Investing Self-Control:
You can take a rigorous approach to investing when it comes to gaining market exposure using mutual funds.
The most common method of investing in mutual funds is through Systematic Investment Plans (SIPS), which enable recurring investments in mutual funds starting at Rs. 500.
Regarding equities, certain brokerages have initiated stock-related SIPs. The crucial thing to remember in this situation is that the appropriate stocks should be chosen, and the SIP amount will change based on the price of the stocks in the portfolio.
6. Tax Advantages:
Equity Linked Savings Schemes (ELSS), a type of mutual fund plan, fall under section 80C, which permits investors to claim a deduction of up to Rs. 1.5 Lakh in a year, even though stocks and mutual funds are taxed similarly. For stocks, there is no such option.
The other tax benefit is that you don’t have to pay taxes when Fund Managers switch stocks. However, if you invest directly in stocks, you may have to pay taxes at the time of stock exit, depending on how long you held the stock.
7. Return Variability:
Mutual funds can generate steady returns over time because to their diversified portfolios, which also helps to reduce risk.
Conversely, stocks have the potential to generate exceptionally high returns. The potential for substantial gains will be constrained by mutual funds’ high level of diversification and restrictions on their holdings in individual stocks. For this reason, HNIs and ultra-HNIs select equities as their vehicles. However, novice investors may not find this stock investment strategy appropriate.
The bottom line
Consider building your own stock portfolio if you are an experienced investor with the time and know-how to examine company financial statements and a knack for research. It should be kept in mind that while stock investing offers exceptional rewards, it also carries a good bit of volatility.stocks and mutual funds
As the founder of index funds, John Bogle, correctly stated, “You shouldn’t be in stocks if you can’t imagine a 20% loss in the stock markets.”Mutual funds, on the other hand, are the best choice for you if you don’t mind having your money managed by a group of professionals whose goal is to yield steady returns over time. Mutual funds offer you a multitude of possibilities that will assist you more consistently reach your goals within the allotted time frames. Therefore, before attempting to invest in stocks, if you are a novice investor who has not yet explored the capital market, begin with mutual funds.
