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Stocks Vs Mutual Funds: What's The Difference?

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Stocks Vs Mutual Funds: What's The Difference?

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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 more 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 fulfil 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. 

What are Mutual Funds?

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 into 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. 

How do you get returns by investing in mutual funds? 

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.

What are the risks 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. 

What are Stocks?

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. 

Why do stock prices go up and down? 

The only aspect that can cause the stock price to fluctuate is buying and selling 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. 

How do you get returns by investing in stocks? 

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/-. 

What are the risks?

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.

Investing in Mutual Funds vs Stocks

The following are the points of comparison in the mutual funds vs stocks debate: 

Which investment is comparatively inexpensive?

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. 

What is the risk involved in investing? 

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. 

Returns: mutual funds vs stocks

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. 

How do investment biases affect you? 

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:

  • Herd mentality is where your action of buying or selling a stock depends on the opinions of peers, friends and relatives. 
  • In recency bias, you tend to forecast market moves based on recent events. For example, you might think that a stock investment might not give positive long-term returns if its price has declined recently. 
  • Loss aversion bias makes you focus totally on not making losses than on making profits. For example, you might avoid selling a stock with no long-term profit potential. You might do this just to avoid a little margin of loss by selling it. 
  • Confirmation bias can make you look for facts, research or news that can support your personal belief about a stock. For example, if you feel that the stock price of Company A will rise soon, you might Google news items about how that company might be the best to invest in, leaving aside its shortfalls. 

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. 

Summing Up

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 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,, 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. 

Frequently Asked Questions

1) Are mutual funds a good investment?

Mutual funds are investments in a basket of securities that are professionally managed. Since these investments are professionally managed, you can avoid investment biases. Furthermore, mutual fund investments can help you automatically diversify your portfolio by investing in different securities like stocks, debt and gold. Even if a mutual fund scheme only invests in stocks, they invest in stocks of different companies, sectors etc. 

This automatic diversification can help you manage your investment risk and return. 

Therefore, mutual funds can be a good investment option for those looking for a diversified, professionally managed and bias-free investment basket. 

2) Are mutual funds more profitable than stocks?

Mutual fund investments earn compounded returns. This means the profit or returns from the securities it invests in is reinvested (added to the principal). Therefore you earn “interest on interest” in mutual funds. 

However, in stocks, you can earn returns in the form of dividends, and the difference between the current stock price and your stock buy price. The returns on stocks are not reinvested to the principal. 

Therefore, you might get more returns in mutual funds than in stocks.

3) What is the average return of mutual funds?

There are numerous schemes available for investing in mutual funds. Different mutual fund schemes have different returns depending on the securities it invests 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. 

4) How long should you invest in a mutual fund?

Your investment horizon (investment period) in a mutual fund depends on the scheme you invest in. 

For example, if you are investing in an equity mutual fund scheme, you can look for a long-term horizon of more than five years. This is because equity prices change rapidly (are volatile) in the short term. 

Similarly, if you invest in a debt mutual fund scheme, you can get stable short-term returns. 

You can stay invested in a mutual fund depending on the security or securities your scheme has invested in.

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