Investors looking to invest in equities have two primary options to choose from: mutual funds and stocks. While both these investment instruments look similar, they differ widely in terms of the investment style, returns and risk. As a smart investor, it pays to know the differences and similarities between these two investment products, so that you can make the right decision.
Here, in this guide, we compare mutual funds vs stocks in terms of returns and risks, helping you choose the right one that best suits you.
Mutual Funds vs Stocks: The Major Differences
What is stock investing?
When you invest in the stock market, you purchase shares of a publicly-traded company. Earnings from the shares are divided into two ways:
Dividends received from the stocks you have invested in
Sale of stocks
What is mutual fund investing?
Mutual fund investing is indirect participation in the share market. Instead of purchasing stocks directly, your fund manager makes the purchasing and selling on your behalf. In mutual funds, you earn via the sale of the units held in your portfolio.
When you choose the "dividend" option, the fund house shares the dividends received on the shares you own with you. On the other hand, when you select the "growth" option, the bonuses are reinvested on your behalf.
Now that you are aware of the definitions, let’s compare the features of stocks and mutual funds.
|Investment Style||The investor purchases a bunch of shares from one or more companies.||The AMC (Asset Management Company) pools in money from several investors to invest in a portfolio of assets.|
|What do you own?||Shares of a company||Shares of a fund|
|Mode of investment||Directly in the stock market||Indirectly – the investor invests in the fund, which invests in equities|
|Who manages the investment?||Investor||Fund house (Fund manager)|
|Risk Levels||High||Comparatively Low|
|How is the value of the asset determined?||By the price of the stock on the market||By the NAV (Net Asset Value) of the fund|
Comparison between Mutual Funds and Stocks based on Risks and Returns
Risks and Returns of Stocks:
When it comes to stocks, individual stock purchases always come with high risks. Since the stock market is highly volatile and unpredictable, even the stock of a reputed company can give negative returns. A few recent examples include Jet Airways, DHFL, Yes Bank, Vodafone Idea, Aircel and more.
The opposite also holds true. Stocks always come with the proposition – high risks, but the potential for high returns. Investing in the shares of companies that are on an upward trend can multiply your investment several times. However, note that it's not always easy to identify and choose stocks that have the potential for generating massive returns. It takes time, speed and expertise.
There are plenty of investors who have lost more money than they have invested in stocks. Dramatic fall in stock prices has the potential to wipe out all your gains.
Risks and Returns of Mutual Funds:
Lower Risks compared to Direct Stock Market Investing
One of the most significant advantages of mutual funds is that even though they invest in equities, the present lower risk compared to stocks. It is because mutual funds have a diversified portfolio, as they invest in various asset classes. Even if a particular stock held in your portfolio offers negative returns, it gets neutralised by the returns generated by another stock. Generally, most mutual fund investments avoid scenarios of negative returns.
Provides the option to invest in Funds other than Equities
Additionally, mutual fund investors can opt for low-risk mutual funds like debt funds that do not invest in equities. All mutual fund houses classify the mutual fund investments based on risk levels. Thereby making it easy for investors to choose based on their risk appetites.
Risks are balanced in the long-term
One complaint raised by mutual fund investors is that mutual funds do not offer huge returns in the short-term. The poor performances of mutual funds get ironed out in the long-run. Fund managers ensure that the portfolio is best adjusted, thereby improving the performance of the fund in the long-run.
Monitoring by the SEBI and AMFI
Additionally, multiple rules and regulations and constant watch by the SEBI (Security and Exchanges Board of India) and AMFI (Association of Mutual Funds of India) ensure that mutual funds do not expose themselves to unsustainable risks.
A rundown on the Differences between Mutual Funds and Stocks:
The Expert Advantage
Purchasing the right stock at the right time is indeed challenging and requires plenty of expertise. Unless you spend a lot of time researching the stock market, picking a winning stock market investment is like shooting in the dark. Besides following the stocks you are interested in, you also have to spend time analysing the industry, following national and international economic trends and more.
With mutual funds, you have expert fund managers who handle all this for you. A mutual fund house has a strong team of stock market researchers who identify the best investments to make on your behalf.
So, if you’re looking for the expert advantage, mutual funds are the better choice.
The Power of Diversification
The golden mantra in stock market investing is, "Not to place all your eggs in one basket." Let's assume that you are planning to invest Rs. 1000 in equities. If you invest directly in shares, you may be able to pick up a maximum of one or two stocks at the most. If the prices of these shares drop, you lose your entire investment.
Now, let's assume that you invest Rs. 1000 in an equity-oriented fund. Your investment is pooled with investments of others to pick up a large number of shares. So, even if one or two stocks in your portfolio don't do well, the others balance it out, thereby helping you protect your investment.
The Convenience Factor
Mutual funds are hands down the winners when it comes to convenience. You can set up a SIP (Systematic Investment Plan), and fixed amounts are withdrawn from your mutual fund account regularly.
On the other hand, if you were to invest directly in the stock market, you have to set up a demat account, a trading account and connect with a brokerage firm, before you can initiate your first transaction.
Small is Beautiful
With mutual fund investments, you can start investing in equities with just Rs. 500 per month. Regular investments benefit from Rupee Cost Averaging, helping you purchase more units at a better than average cost per unit.
The Availability of Choices
Contrary to popular belief, mutual funds are not just equity-oriented. There are plenty of fund types like – debt funds, hybrid funds, sectoral funds, themed funds, large, mid and small-cap funds and more. You can choose the right fund type based on your investment horizon, investment goal and risk appetite.
Another considerable advantage of mutual fund investments is that it can help you enjoy tax-savings. Certain types of funds like ELSS (Equity-Linked Savings Schemes) help you reduce your taxable income under Section 80C of the ITA if you opt for the old tax regime.
When you invest directly in the stock market, you have to pay STT (Securities Transaction Tax) and brokerage fees. Additionally, you have to maintain a Demat account, which costs a fee. Compared to these costs, the costs of investing in mutual funds is much lower.
Which is the better option: Mutual Funds Vs Stocks?
Ultimately, it depends on the type of investor you are. If you’re a beginner investor, who wants to invest in stocks but don’t have the time to spend researching the stock market, mutual funds are the better choice for you.
However, if you are an expert investor, who has a clear understanding of trading, then you can go for investing directly in shares while maintaining a couple of mutual funds.