Which is a better option: Stock or Mutual Fund ?
Over 1 crore of new Demat accounts was opened in the previous year. Just 49 lakh demat accounts were opened in 2019 in order to bring that into perspective.
There is no doubt that interest in equities has spiked with the financial markets back to all-time highs, whether it was the lockdown or the market rally, or low deposit rates.
But should investors invest in shares for the first time by purchasing stocks directly, or should they opt for mutual funds? In this blog, we look at each of the positives and negative sides so that when you decide to park your hard-earned money in the stock market to reach your financial goals or want to build wealth for the long term, you can make an informed decision.
Stocks are financial instruments issued by companies that give part ownership of a company to investors. Investors stock their surplus mainly for capital appreciation, dividends, as well as voting rights, allowing them to be part of important business decisions. Stocks are also classified in common parlance as securities and as equities.
Mutual funds are financial vehicles in which, depending on the investment purpose of the fund, capital is mobilized from multiple investors and invested in various asset classes such as equity, debt, gold, etc
While both of these options allow you to invest in equities, you should take the Mutual Fund route for more than a few reasons. Some basic reason is as follows:
Diversification of Portfolios
Mutual Funds invest in a large stock universe that offers outstanding portfolio diversification and eliminates the risk of concentration. A decent number of the industry’s diversified funds have 50 or even more stocks in their respective portfolios.
This diversification helps to reduce portfolio losses in the event that 1 or 2 stocks are harmed due to such negative events. The fact that only 10% of exposure to a single stock can be taken by equity funds also minimizes the risk factor in the investments
The stock portfolio of an investor usually appears to be 10 to 15 stocks. This is similar to higher portfolio volatility, which would be measured as the market goes up and down.
Today, you would need a huge amount of money if you want to get the same kind of diversification as a mutual fund. In addition, there are expenditures involved in purchasing and selling. For e.g., if you wish to buy 1 share of each of the constituents of NIFTY 50, you will need more than Rs. 1 lakh.
The advantage of mutual funds is that an investor gets exposure to a large range of stocks through market capitalization and various sectors in his portfolio, even by investing a small sum of only Rs. 500 in a mutual fund.
With a fund management team that does a lot of research on stocks, sectors, and the economy, mutual funds are professionally managed.
This team spends a large amount of time reviewing the financial statements of the companies and meeting with the management of these companies until they decide on the universe of stocks, which helps them to get a holistic view of the stocks to be included in the portfolio.
Most fund houses are also proficient in a robust risk management process that puts strict binding constraints on their portfolios, which in turn does not allow the fund management team to take undue risks.
Investors would have to spend a significant amount of time researching stocks and various sectors to understand the headwinds and tailwinds in the underlying market.
Investors dealing directly with stocks should also have a fair understanding of the macro-economic situation, giving them a clear outlook on which industries and stocks will be able to perform well in the future.
This is an important exercise that investors need to do, as their portfolio of 10 to 15 stocks needs to be diversified according to their risk profile across market capitalization and sectors.
In other terms, most of the aspects that the fund management team of fundamental analysts, technical analysts, economists, and risk modelers do must be done by the individual investor. That is definitely not the cup of tea of a beginner investor from a time & effort perspective.
In terms of the cost-benefit, one of the economies of scale enjoyed by Mutual Funds is due to the large transaction volumes involved in the purchasing and sale of stocks.
In addition, SEBI launched Direct Plans for the Mutual Fund Industry in 2013. In a direct plan arrangement, the fund houses subtract from the operating costs the fee-fees to marketers, resulting in a lower cost ratio for the investor.
If you purchase stocks directly, you will have to pay charges such as brokerage, STT, SEBI turnover charges, GST, transaction fees, etc. But the good part is that these costs tend to be minimal over the long run unless you do frequent daily stock trading.
Variety of Options
You have a wide range of options for pursuing your financial goals when it comes to Mutual Funds. Different funds, such as equity funds, debt funds, gold funds, foreign funds, etc., catering to various asset groups.
There are also funds that fulfill particular purposes, such as retirement and plans for children. The other possible alternatives are active and passive funds. Depending upon their risk profile and time period, you will decide on the choices.
So, if your risk profile is cautious, then you can choose from a range of small-exposure debt funds to equity-side large-cap funds. On the other side, you can get across the market capitalization curve and also have sector funds in your portfolio if you are an active investor.
If you have a time horizon of 1 to 5 months, from a tenure perspective, then he can go in for liquid funds, while the short-term/corporate bond funds would be a good match for a 3-year time horizon.
There is just 1 asset class as far as stock investment is concerned. Of course, there are over 5,000 companies to choose from within the stocks, but there are usually only 500 odd companies that are investable in the Indian stock exchanges.
The wide range of options available in Mutual Funds offers you a lot of benefits that are not available when investing directly in stocks, such as particular categories or funds to accomplish targets, diversification, debt exposure, etc.
When it comes to exposure to the markets, mutual funds allow you to pursue a disciplined approach to investing. The most common way to invest in mutual funds is through Systematic Investment Plans (SIPS), as they allow you to make a daily investment of as little as Rs. 500 in mutual funds.
Some brokerages have begun SIPs into inventories as far as stocks are concerned. The key thing to remember here, however, is that the correct stock selection should take place, and the volume of the SIP can vary according to the price of the stocks included in the portfolio.
- Tax benefits
While the taxation of equity mutual funds and shares is the same, section 80C enables investors to demand a deduction of up to Rs. 1.5 Lakh per year from the Equity Linked Savings Schemes (ELSS), a form of mutual fund scheme. For stocks, there is no such choice.
The other tax benefit is that there is no tax to be charged by you when fund managers move across stocks, while in the case of direct investment in stocks, depending on your holding period, you will have to pay taxes once you leave a stock.
Variability in Returns
The diversification of the portfolio of mutual funds not only helps to reduce risks but also makes it possible to receive stable returns over time.
Stocks, on the other hand, have the potential to gain superlative returns. As mutual funds have caps on their holdings in each stock and are highly diversified, there would also be limited ability to earn high returns.
This is why, for HNIs and ultra HNIs, stocks are the chosen vehicles. This approach to investment through stocks, however, may not be sufficient for new-to-invest users.
Recent update on 2021: Mutual funds income Taxation is analogous to income from non-mutual funds under the short-term/ long-term capital gains and dividends for non-corporates/corporations & non-resident Indians.
Rajput Jain and Associates would like to shed light on the importance of SIP in mutual funds. Systematic Investment Plans allow you to invest consistently, making market volatility your ally rather than an suggestion. By investing a fixed amount at appropriate time level regular intervals,
Systematic Investment Plans encourage systematic savings, averaging out expenses over time and possibly optimising returns over an extended period of time. This Systematic Investment Plans approach makes wealth accumulation more accessible by offering a simple yet efficient means to harness the possibilities of financial markets.
RJA believe that an informed decision present Situation can shape a brighter financial future, & we’re here to provide appropriate guide you each & every step of the way.