If you look from a retail investor perspective, the two most popular modes of investment - Mutual Funds & Stock Market witnessed a rapid rise in numbers. The Association of Mutual Funds of India (AMFI) reported almost 5 Cr SIP accounts by the end of Dec 2021, with a total asset under management (AUM) in excess of ₹37.73 Lakh Cr. Reports suggest that a staggering 14.2 million new Demat accounts were opened in the financial year, almost thrice the number compared to the previous year.
The new wave of investors is willing to take calculated risks and invest in tools with more awareness and ambition to get higher returns. However, the one question that often pops up is - mutual funds or stock market; which is better? Let us try to address this by understanding the merits and risks of each so you can fit them in your unique context before deciding.
Mutual Funds vs Stocks - A Quick Snapshot
While there is so much to jump into when we discuss the differences between mutual funds and stocks, here is a quick snippet to keep in mind before your next steps.
Let us now examine both these popular investment tools based on these parameters.
Mutual Funds - An Evaluation
- Nature of investment: Mutual funds are an indirect form of investment as the fund house pools together money from different investors to invest in a basket of equity-related securities. As an individual investor, you get certain units assigned in proportion to the amount you have invested based according to Net Asset Value (NAV) prevailing in the market. So, if you have invested ₹10K in a Mutual Fund with a NAV of ₹50, then you get 200 units to your name.
- Degree of Diversification: Since a mutual fund is a collection of stocks of different companies (in varying proportions), your investment is actually spread across companies. This leads to diversification. The main benefit of this is lower risk exposure. Say your MF has invested across stocks of 5 different companies; even if 1 of them underperforms, the performance of the remaining four can offset your losses.
- Liquidity: While mutual funds can be redeemed whenever you wish to do so, it is done as per the NAV that is decided at the close of each trading day. Moreover, many MFs come with an exit load which is a small penalty (usually 1%) that is charged if units are redeemed within one year of purchase.
- Individual Control: A fund manager is appointed to manage the portfolio allocation and rebalancing of the mutual fund's underlying assets. You can only invest in it or redeem it as per your choice. Beyond that, you have no say in the portfolio mix.
- Convenience and Flexibility: Mutual funds are possibly the easiest to invest in. As long as you have a PAN Card and a linked bank account, you can choose to invest in MFs directly, through an agent/broker, or directly through the fund house. Moreover, you can also invest in a lump sum amount or via the Systematic Investment Plan (SIP) with smaller amounts as per your convenience and affordability.
- Tax Benefits: The Equity Linked Savings Scheme (ELSS) is a unique form of MF that gives you tax benefits under the Sec 80C of the Income Tax Act of India of up to ₹ 1.5 L per annum. It comes with a lock-in period of 3 years, which is lower than almost all other tax-saving instruments in the country.
- Risks: Clearly, all financial products come with an element of risk. This needs to be properly absorbed and evaluated before investing in any instrument. In the case of mutual funds, there is a concept of the ‘risk-o-meter’, which lets investors know the degree of risk associated with the funds. Moreover, due to the vast variety of MFs (like equity, debt, commodity, etc.), you can browse and invest in the best one, that fits your risk profile.
Shares & Stocks - An Evaluation
- Nature of investment: When you buy shares, you are actually buying a proportionate ownership of the company. This makes them a direct form of investment. Your gains and losses are in direct relation to the performance of the company you have invested in.
- Degree of Diversification: You can only buy shares of one company at a time. In other words, if you wish to diversify across sectors or companies, then you need to make individual investments in each one of them. This may also require more money and a higher level of tracking effort.
- Liquidity: Shares are highly liquid and can be sold anytime during the trading day at the last trading price (LTP). Since the price may change several times during the day, you can time your ‘sell’ transaction to get the best returns and have it seamless transferred to your account.
- Individual Control: Being a direct form of investment, you have entire control over your investment choice. You can decide which stock to buy (or add to), which to hold, and which to sell. While you may choose to make use of a brokerage to manage your portfolio, it is entirely at your discretion.
- Convenience and Flexibility: Between mutual funds vs stocks, stocks are a less flexible form of investment. Firstly, as mandated by SEBI, you need to have a trading account and a Demat account. Secondly, there is no concept of SIP for traditional stocks.
- Tax Benefits: There are no tax exemptions applicable to share trading.
- Risks: Considering that stocks have direct equity exposure, they are significantly impacted by the market volatility. This exposure and risk also affect the mutual funds vs stocks returns ratio. You may choose to invest in stocks of different companies and sectors as a means to hedge your portfolio. Still, market downswings can never be truly predicted. Careful and thorough research is far more vital while investing in the share market.
Armed with this knowledge, you can now decide which works the best for you. Based on your financial goals, the preferred mode of investment, affordability, and risk appetite, you can decide to invest in mutual funds or the stock market, whichever is better for you. Just remember, the underlying principle is common in both of them - which is - careful evaluation of pertinent investment parameters, not getting carried away by word-of-mouth or the excitement of the moment, and falling prey to bogus quick-buck schemes.
Are mutual funds better than stocks?
This entirely depends on your own unique investment goals and objectives. Mutual funds are recommended for new investors or those who do not have experience in evaluating company performance and tracking market movements. It is a convenient way to invest for those who do not get the time to track their portfolio frequently since mutual fund managers do this for them.
Are mutual funds safer than stocks?
All financial instruments have their own set of risks. The difference is that mutual funds come in several types and forms, ranging from high-risk equity funds to low-risk debt funds. This variety helps you diversify your portfolio and distribute your risk across your various investments so that the overall value doesn’t go down if one company is performing poorly. Stocks, on the other hand, have direct market exposure and dependency on the performance of the specific company you own a share of. Hence, a higher risk element.
Are mutual funds more profitable than stocks?
The old adage, ‘high risk, high rewards’ is true in the financial market as well. Since stocks tend to come with higher risks, there is potential for higher gains. That is not to say that mutual funds cannot provide handsome returns. In the end, it entirely depends on the performance of the underlying assets and how much you have invested in them.