Do you remember saving up your pocket money for the first time as a kid? You must have spent some of it and saved some for something that was very expensive but you really wanted. That was probably your first and most basic lesson in money management. You tend to save because you want to accumulate more money than is available to you through your income. The same purpose applies to investing and comparing mutual funds vs stocks.
When you start earning, you want to see your money grow because you might be unable to fulfill your goals with just your monthly remuneration.
And investments like mutual funds or stocks can help you do that. Investing can help your monthly salaries accumulate over time, grow with compounding, and reach your goals.
Now, coming to choosing investments that can suit your various goals. You have numerous investment products to choose from. There are stocks, mutual funds, debt, gold, and more.
One of the popular debates is about investing in mutual funds vs stocks.
Let’s understand how investing in mutual funds or stocks can affect your goals differently.
But before we get to that, here’s a quick explainer on the difference between mutual funds and stocks.
A mutual fund is a basket of securities like shares, bonds, gold, and more. To invest in a mutual fund, you can choose among various mutual fund schemes.
Consider these schemes as a set-top box package. And how do you choose a set-top box package?
If you are someone who likes sports, you may end up purchasing a package with more sports channels. And if you love watching sitcoms, you may look for those packages with channels that telecast your favourite series. And even in these packages, some might offer more Hindi, English, or K-drama shows.
Mutual fund schemes are similar to these kinds of packages. Some schemes offer more equities or stock investments. These are called equity mutual fund schemes. Similarly, some schemes invest more in debt. These schemes are called debt mutual fund schemes. Also, some schemes invest in gold. These are called gold mutual fund schemes.
You can choose mutual fund schemes based on your preference for risk and returns. Before we look at the risks, let’s learn about the returns.
A mutual fund scheme invests in different securities like stocks, bonds, and more. When the price of these securities rises, your mutual fund scheme can earn a profit. This profit or mutual fund returns can be measured with the help of a scheme’s Net Asset Value (NAV).
The NAV of mutual funds is the current total market value of all the securities it invests in. To get positive returns, the current NAV should be higher than it was when you invested in the mutual fund scheme. It's also a good practice to know how to calculate your returns when you get into the journey of investing in mutual funds.
The risk of a mutual fund scheme depends on the risk of the underlying securities. For example, if the mutual fund invests more in shares, its risk will depend on the stock market. If the price of the stocks that form the scheme package goes down, the scheme NAV can also decline.
Next, let’s examine the stocks. This topic will help you understand the debate on mutual funds vs shares.
Stocks are securities that show how much ownership you have of a particular company. They are synonymously known as shares or equities. When you buy shares of a company, you become their shareholder.
Continuing with the above example of set-top box packages, consider investing in stock as paying for a single channel. Or, imagine choosing individual channels and paying for them separately.
But one thing you should know about stocks is that their price tends to fluctuate a lot in the short run. Let’s learn about it next.
The only aspect that can cause the stock price to fluctuate is buying and selling of stocks. You can relate it to the dynamic pricing of plane tickets.
When there are more tickets available, the ticket price is lower. As more and more passengers book their tickets, the demand for the tickets increases, and so does their price. The same happens with the stock prices.
When more and more investors buy the stock, its demand increases; with the increase in demand, the stock price rises. Similarly, when many investors are selling their stocks, the demand falls, and the price of the share also decreases.
You can get returns from stocks in two forms. One is the dividend, and the other is the rise in stock prices.
As you buy ownership of a company by buying its stocks, you will be distributed a part of its profits. This part of the profit will be in proportion to the size of your shareholding or ownership of the company.
Another type of return is when the share price exceeds your buy price. Suppose you bought a share at ₹100/-. Now, if the share price becomes ₹110/-, then your return is ₹10/-.
You cannot predict where the price of stocks might move. This fluctuation in price is because the stocks are dependent on the investor sentiments. Investors anticipate that the prices will increase if there is a positive sentiment toward a stock. So, there will be more investors buying the stock.
Similarly, if investors have a negative sentiment around the stock’s future price, they might sell more and more stocks. This situation can bring the price down.
Now that we have understood the difference between these investments, let us now examine the mutual funds vs stocks debate.
The following are the points of comparison in the mutual funds vs stocks debate:
Investing in mutual funds can be relatively cheaper than investing in stocks.
But why?
Building on the set-top box example mentioned above, buying a package of preferred TV channels can be cheaper than paying individually for each channel.
The same instance can be applied to investing in mutual funds vs stocks.
You can invest in a mutual fund scheme by starting a Systematic Investment Plan (SIP) for as little as ₹500. Therefore, even with a single investment of just ₹500, you are investing in different securities like stocks, bonds, and more.
Even when you invest in a single security, say stocks, through a mutual fund, you invest in stocks of different companies together through a single scheme.
However, investing in each stock can be comparatively expensive. This is because you have to pay for each unit of stock separately.
For example, say you are investing in stock A worth ₹100, stock B is worth ₹500, and stock C is worth ₹400. Now, buying a single stock of A, B and C can cost you ₹1000. In contrast, you can invest in a basket of these stocks through a mutual fund scheme.
If we compare mutual funds vs stocks, the degree of risk might be higher in stock investments. The main reason is that we might rely only on our selected stock investments for returns. However, in mutual funds, you can choose hybrid funds or balanced funds, which are a mix of stock and debt investments. Debt investments are unaffected by market risk and can offer stable returns. Therefore, they can help manage your risk.
Moreover, many options are available for investing in mutual funds that might invest in debt, gold, and even other mutual fund schemes. These investments can help you diversify your portfolio and manage the risk level of your investment.
In mutual funds, your returns have the power of compounding. Compounding means the “interest on interest” earned on the principal investment. During the period for which you stay invested in a mutual fund, the profit earned by the securities it invests in is reinvested in the fund. You cannot achieve the benefit of compounding if you invest in stocks.
The returns on stock investments can be earned through profit distributions like dividends and the difference between a stock’s current price from its buy price.
Also, the returns on mutual funds might sometimes not be able to match that of stocks. This is because mutual funds are a basket of stocks where a rise or fall in the price of a single stock might not have much impact on the returns. Your investments are automatically diversified.
However, for stocks, a significant rise or fall in the price of a single stock will determine your returns from that stock.
It is not just the returns but also the risks that are diversified in mutual fund investments, making it better for investors wanting to test the waters in stock investing.
Numerous investment biases can impact your choice of buying or selling a stock. Some popular biases affecting your investments are herd mentality, recency bias, loss aversion bias, and confirmation bias.
Let us briefly understand them:
With these biases, you can make short-sighted stock investment decisions. Because your investment decisions here are not based on facts but biases, you might fail to achieve your financial goals.
You can avoid these biases by investing in mutual funds because you select a basket of stocks instead of picking them individually. This basket of securities is managed by seasoned professionals called fund managers.
The fund managers of mutual fund schemes make investment decisions based on their experience, knowledge, and thorough market research.
Investing in mutual funds vs stocks depends on factors like risk, returns, monthly or periodic investment commitment, and investment decisions. Having a fair idea of what is better for you can help you a great deal. Mutual funds can be a better option if you are looking for professionally managed investments that can automatically diversify your risk and returns with smaller and periodic investments.
However, if you are looking to pick and choose stocks and diversify your risk and returns on your own then stock investments can be a better option.
No matter what you choose, diversifying your risk and returns and avoiding biases can help you reach financial goals in a better way.
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Mutual funds can be a good investment option for those who want to diversify their portfolio and leave the investment decisions to professionals. They offer a wide variety of assets without having to purchase investment securities one by one. However, mutual funds come with their own set of advantages and disadvantages. It is important to consider your risk tolerance, investment horizon, and financial goals before investing in mutual funds.
Mutual funds and stocks are two different investment options that come with their own set of advantages and disadvantages. While stocks can provide higher returns than mutual funds, they are also more volatile and carry higher risk. On the other hand, mutual funds offer diversification and professional management, which can help reduce risk and provide stable returns over the long term. It is important to consider your investment goals, risk tolerance, and investment horizon before choosing between mutual funds and stocks.
There are numerous schemes available for investing in mutual funds. Different mutual fund schemes have different returns depending on the securities they invest in, like stocks, debt, gold, etc. The average returns in an equity mutual fund scheme might be higher than in a debt mutual fund scheme.
The ideal investment horizon for a mutual fund depends on your financial goals and risk tolerance. If you are investing for a long-term goal, such as retirement, you can consider investing in mutual funds for a longer period of time, say 10 years or more. However, if you have a short-term goal, such as saving for a down payment on a house, you may want to invest in mutual funds for a shorter period, say 3-5 years.
