Direct Stocks vs Equity Mutual Funds: Which is Better?
If you ask anyone if they have invested in equities, the most common response that you will get from them is, ‘no baba; it is very risky. I am happy with my fixed deposits.’ Their response stems from what they have seen in their friend circle or what they have experienced. While everyone knows that equities give the highest return on a long-term basis, the risk associated with it deters many investors from investing in equities.
However, what many people do not know is that there is another smooth way to take equity exposure, and that is through mutual funds.
Mutual funds pool money from many investors and expert fund managers manage it. While you can pick up the stock of your choice when you are directly investing in equities, the fund manager takes the investment calls in a mutual fund.
Here’s some of the differences between Mutual Funds and Direct Stocks that will help you to figure out the right option for you.
You don’t need to be an expert to invest in mutual funds
When you invest in equities through mutual funds, you don’t need to be an expert in stock picking. Fund managers pick up stocks that they expect will be the best for their investors according to their investment objectives. In the case of direct equities, you will have to do the research and pick up stocks. In many cases, it is seen that many people invest in stocks as per their friend’s suggestion, and this is where they go wrong and end up with sour memories. Investing in direct stocks requires expertise. If you are new to the world of investing, investing in mutual funds will be the better option for you.
The risk in mutual funds is lesser than investing directly in stocks
The risk associated with direct stocks is higher than investing in mutual funds. Mutual funds have a diversified portfolio, and fund managers invest on an average of 30 stocks across different sectors and market capitalization. This reduces the risk associated with an individual stock. E.g., if stock A is not performing well due to some sector-specific problem, the underperformance of the stock will be offset by the other stocks in the portfolio.
Moreover, the market regulator has capped the investment in a single listed stock at 10%. That means that if the total assets of the fund are say Rs.100, then the total investment in one stock can’t be more than Rs.10. This reduces the risk when compared to investing in direct stocks, where the total allocation to a single stock in your portfolio would be higher.
Equity mutual funds are for the long run
Equities tend to be volatile in the short term, but in the long term, the returns tend to average out and give more attractive returns than other asset classes. Direct stocks can be for trading and investing purposes. However, equity mutual funds are only for the long term. Equity funds may give attractive returns if you stay invested for more than five years.
Fulfill your goals through SIPs in equity mutual funds
One of the most important parts of investing is discipline. Having a disciplined approach will make sure that you can meet your goals. Mutual funds have a facility through which you can invest a fixed sum of money periodically called as a systematic investment plan(SIP). By investing in equity mutual funds through SIP, you will be investing in a fixed amount of money irrespective of the market levels. Rupee cost averaging is one of the most important benefits of SIP. Through SIPs, you will be allotted lesser units when the market is going up and more units when the market is low. Once the SIP mandate is set, the investment amount will be automatically debited from your bank account. This gives you the best of both worlds. However, in the case of direct stocks, you do not have the option to automate your investments and pay a certain amount of money every month.
When choosing whether to go for direct equities or through mutual funds, you need to ask yourself what kind of investor are you. Do you have the market knowledge or the time to do extensive market research to pick the right stocks for yourself? Can you bear the risk associated with investing in just a few stocks? If the answer to these questions is a resounding NO, then investing in equities through mutual funds may be the best option for you.
If you want to know more about investing in mutual funds, get in touch with a financial advisor. He or she will be able to guide you and clear all your doubts. Happy Investing!