For the longest time, investment in stock markets was thought to be only for the rich and the elite and a very risky proposition that can simply erode one’s hard-earned money. Stock market investments are often equated with gambling and we have all heard our elders say at some point in time to stay away from stocks. The multiple frauds and scams in the stock markets have also contributed to this general notion but today the scenario is no longer the same. Investors today have multiple investment options to choose from depending on their investment goals and create a tailored portfolio that can suit their pockets as well as return expectations. Mutual funds are a classic example of the same and the buzz around them has increased quite a lot in recent decades, especially after the pandemic. Therefore, one of the many questions that investors, especially new investors face is what should they invest in, pure stocks or mutual funds. Given below is a brief discussion relating to the same that can help investors understand stocks and mutual funds better and make suitable investment decisions.
We have all heard the words shares and stocks but what is the exact meaning of these terms? Shares are the individual unit of the equity capital in the company. By investing in shares, investors get to be part of the ownership of the company along with voting rights and the right to returns in the form of dividends and net profits at the time of liquidation. The investor’s collective holdings of shares in one or more companies represent their total stocks or aggregate holding in a company which is usually represented as a percentage. On the other hand, mutual funds are investments in a diverse pool of assets (equities, debt instruments, money market instruments, gold, etc.) in a single fund. Investors can invest in units of mutual funds through lumpsum investment or through SIPs at their convenience. The fund is managed by the fund managers who are in charge of the investment decisions and strategies to navigate the fund through the various market trends. Investors can invest in various types of categories of mutual funds depending on their risk-return profile and investment horizon.
Now that we know the basic meaning of shares and mutual funds, let us understand the difference between the two.
| Category | Shares | Mutual Funds |
|---|---|---|
| Meaning | Shares are the individual portion of the equity capital usually split in face value of Rs. 10 each. Investment in shares gives the shareholder ownership in the company up to the value of the shares held by them. | Mutual funds are a collection of investments in shares, bonds, other debt-related instruments, real estate, etc. |
| Diversification | Investors do not get the inherent benefit of diversification by investing in shares. A diversified portfolio has to be created by the investors themselves by investing in shares of different market capitalization as well as by investing in different types of assets. | Mutual funds have the inherent benefit of diversification as the asset pool is made of not only shares of varied market capitalization but also of a different class of assets depending on their Scheme Information Document. |
| Fund manager | There is no concept of a fund manager in shares. Investors have to navigate their investment portfolio on their own based on their knowledge and experience. Therefore, the primary requirement of investment in shares is to have a thorough understanding of the markets to understand each instrument and their volatility to the changing market trends. | Fund managers are the drivers of a mutual fund and are responsible for the fund’s performance. An experienced and qualified fund manager with a deep understanding of the markets is the key to a successful mutual fund. |
| Taxation | Short-term gains from equity shares are taxed at a flat rate of 15% while long-term gains are taxed at 10% after the initial exemption of Rs. 1,00,000 | SEBI has categorized mutual funds into different categories based on their asset composition. Taxation of mutual funds depends on the composition of the fund, i.e., the dominant asset class as per the guidelines of SEBI. |
| Cost of investment | The cost of investing in individual shares to create a substantially successful investment portfolio is quite high compared to investment in mutual funds. | The cost of investing in mutual funds is lower as investors have a lower expense ratio. Also, investors can invest in mutual funds through SIPs which lowers the average cost of investment over time. |
| Investment strategy | The investment strategy for investing in stocks is basically along the lines of active investing as the investors have to create their portfolio and have to continuously monitor the same to ensure the overall profitability of the portfolio. | Mutual funds can be broadly categorized into active funds and passive funds. Investors with aggressive risk-taking abilities prefer active funds while risk-averse investors usually prefer passive funds that have considerably lower risk and more or less stable returns. |
| Control of investment portfolio | Investors have complete control over their investment portfolio by directly investing in stocks. | Investors have no control over the fund composition as it is decided by the fund manager based on their internal investment strategies within the guidelines of the SID. |
| Risk and return | The risk of investment in pure stocks is always higher as compared to any other investment option. Also, stocks are the most volatile form of investment and can create unprecedented returns in an uptrend depending on the sensitivity of the stock to market fluctuations. | The risk in mutual funds is lower as compared to stocks as they have the benefit of diversification. Also, there are various types of mutual funds that invest in low-volatility securities. This further reduces the overall risk of investment. On the other hand, the returns are lower than investments in pure equities in a similar uptrend. However, since most mutual funds invest in debt instruments too, the returns are relatively stable when compared to stocks. |
Now that we have seen the meaning and the key features of each of these products, how to determine which one is better? The answer to this question may not be a “one shoe fits all” kind of answer. Investors who may have a good understanding of the market and can navigate through the market fluctuations in the most optimum manner as well as a high-risk appetite can invest in stocks and create their own portfolio. On the other hand, risk-averse investors, or investors with little to no understanding and experience of stock markets or time to manage their own portfolios can opt for mutual funds. The investment decisions will also depend on the investment capital available to the investors. A financially sound investor who can afford to invest a substantial amount in stock markets along with other factors mentioned above may also prefer to invest in stocks directly rather than going through mutual funds. Similarly, investors with limited funds who are looking to gradually build their portfolio through small investment capital over a long-term investment horizon will prefer investing in mutual funds.
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The critical differences between stocks and mutual funds help the investors understand these products in a better manner as well as help them have reasonable expectations in terms of risks and returns. However, recent years have shown a growing preference for mutual funds and an influx of especially small and retail investors in the market looking for essentially inflation-beating returns. So what do you prefer for investment; stocks or mutual funds? Do let us know what you think is better according to you and can help you secure your future; because that's the ultimate goal right?
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TrueData Team