Your decision on investing through mutual funds or buying stocks directly depends on the 3 R factors:
Most people fancy investing in stocks and becoming billionaires. But they conveniently forget that only a few people in the world have been able to do it successfully. What sets them apart from the others?
Let’s look into all the 3 factors in more detail.
Risk – Is investing through mutual funds riskier than direct equity?
Buying stocks directly is a riskier proposition than investing through mutual funds. Why so?
It because of the level of concentration or diversification in your portfolio. Most diversified mutual funds have around 45-60 stocks in their portfolio which helps them to manage risk. The impact of failure of one stock will not be so much on the mutual funds as it would be in a concentrated stock portfolio if you buy directly.
Can we not replicate the mutual funds and buy more stocks to diversify risk? Yes, we can.
But it defeats the very purpose of buying stocks directly, which is, to have a focused stock portfolio and maximize the gains of multi-bagger stocks – the original fantasy of being a billionaire.
Secondly, it takes much more money to do it directly.
If you are investing through a mutual fund, diversification can be achieved with small amounts of money.
Return – Does direct equity investing give higher returns?
It is common knowledge that there is a risk-return trade-off in every investment. The successful investor is one who manages the trade-off well. A concentrated portfolio of stocks can achieve very high return if the stocks chosen are good ones or multi-baggers. On the other hand, they can also produce huge loss if the stocks chosen are rotten ones.
In a mutual fund, a professional fund manager does the stock picking and they have research systems in place. Mutual funds are also highly regulated in India which provides an extra safety net for the investor. Due to diversification, the returns on mutual funds may not be extraordinary but it is possible for a good fund manager to beat the market returns through excellent stock picking. So investing through a mutual fund lowers your returns on the higher side but also lowers the declines on the lower side.
As far as the costs are concerned, you need to incur a cost for both options. A fund charges a management fee which is adjusted in the NAV (net asset value) of the funds. If you invest directly, you will incur brokerage costs and annual maintenance costs for demat accounts. It may be presumed that investing in stocks directly is cheaper due to discount brokerages and low cost demat accounts, but if you are frequently buying and selling, the costs may add up very fast.
Research – which option demands greater attention?
As mentioned above, success depends on good research. Good research needs continuous learning and ample amount of time. If you cannot spare the time or if you are unwilling to learn, it is better to invest through mutual funds. If you are passionate about learning and you can afford to spend the time, you can invest directly into stocks.
Fundamental and technical research of stocks are both very huge fields of study in themselves. There are professionals in the stock market who are making a career out of it. So if you are a lay person, do not assume that research is easy and going through a few websites is going to help you beat mutual fund returns over the long term. You may get lucky in the beginning but long term outperformance is very difficult and even professionals are not able to do it consistently.
If you are the person who is depending on your friend or stock broker for “tips” – direct equity is not for you. If you are well read and you can form buy or sell decisions on your own with conviction, you may go for direct equity.
Mutual funds also require some amount of research because all funds are not the same. So you may have to dig into their past performance, potential for the future and take an informed decision. However, it still holds less risk of going wrong than direct equity.
Conclusion – is investing through mutual funds the better option for you?
If you are a person who has time and inclination to do your own research and a higher capital to invest based on your own conviction, you can go for direct equity. For all the others, investing through mutual funds is the better option.
Mutual funds also offer convenience features to the lay investor like:
- Ability to invest small and invest regularly
- Liquidity because the mutual fund itself buys and sells units
- Variety of asset classes – like equity, bonds, gold, real estate, overseas investments, etc
- Variety within asset classes – like diversified equity, sectoral equity, thematic funds, funds segmented by market capitalization, short term debt funds, long term debt funds, dynamic debt funds, asset allocation funds, multi-asset funds, hybrid aggressive funds, hybrid conservative funds, etc and a whole lot of variants in each of them.
- It is like an investment supermarket, where you can choose what you want and create the right mix for your needs.
Replicating this on your own is possible but an expensive affair both in terms of money and time. Hope this helps you to make the right choice. Get access to superior research and an online investment platform.