Most of us feel that investing in direct company stocks is risky. Of course, it is. But so is investing in mutual funds, for the simple reason that mutual funds also invest in company stocks. You may feel that mutual funds is still safer because of the expertise that the fund house has as regards fund management and detailed analytical reports, but then remember that rewards are always in proportion to the risk. Let us do a pointwise analysis of Mutual Funds and Stocks...read on...
The fact of the matter is that Mutual Funds and Stocks are as much different investment tools as Fixed Deposits and Public Provident Fund. Mutual funds have a lower risk, lower reward in proportion to stocks which possess high risk, high reward. So, an individual's risk appetite is the primary factor which drives the selection of one of the investment tools amongst Mutual funds or Stocks.
In the developed markets like US, Europe and Japan, individual investors tend to hold stocks primarily through Mutual Funds. Let us understand some of the inherent merits of investing through mutual funds, rather than directly through stocks:
Merits of Mutual Fund Investing
(1) Invest and Relax
One of the main benefit a Mutual Fund provides is that you don't have to pick stocks. Picking stocks, tracking them, making sector and asset allocation, buying and selling stocks when required, are all best done by a professional fund manager, though on a chargeable basis.
It’s managed by a professional fund manager who'll ensure your portfolio continues to contain good stocks with potential for long term returns.
(2) Short-term profit booking advantage
When an individual manages a portfolio of stocks, there will most likely be some selling and buying. If the selling of stocks is done within one year of purchase, there is an incidence of short term capital gains tax.
Whereas for a fund manager, there is no capital gains tax, even if it were to book short term capital gains for the fund he manages. This will trickle down as benefits for you as an investor in that fund. The short term capital gains tax will come into picture only if you withdraw from the fund in less than 12 months.
(3) Instant diversification of portfolio
Typically, in order to have a well balanced portfolio, you would need to have about 25-30 stocks in your portfolio. This can lead to a good mix of performance and stability. Such a basket approach can be achieved if you have a large enough corpus. As an individual, you may not have sufficient funds or mental bandwidth to create a sufficiently diversified portfolio of stocks.
Mutual funds provide instant diversification. Since you are buying units of the mutual funds that are spread across several stocks, you receive diversification benefit without investing a huge corpus.
For someone who want their money to grow safely, generating inflation-beating returns, and not having to worry too much about where and when to invest, and have limited amount to invest - Mutual Fund is an excellent investment tool. Returns are very good, though relatively much lower than direct stocks.
Mutual Funds is good for beginners in financial investments...in fact an ideal investment tool for them.
But if you must get seriously wealthy, you cannot ignore the merits of Stock Investing vis a vis Mutual Funds:
Merits of Stock Investing
(1) Learning
The biggest drawback of Mutual Funds is that it doesn't teach you anything about stocks, stock analysis, valuation, companies etc. You just don't learn anything, and in the long run, if you don't learn about companies, stocks, EPS, intrinsic value calculation and a few other fundamental stock picking techniques, your wealth will always be far behind those who invest directly in stocks.
(2) Rewards
Since the risks are relatively higher in stocks, so are the rewards. The average returns for a person who has learnt for 10 years and is now investing in stocks can be anywhere between 30-70% while the average returns from mutual funds are likely to be between 20-25%.
(3) Hone your enterpreneur skills
In direct stock investments, you control where to invest, how much to invest, when to come out etc. You operate more like an entrepreneur when investing in stocks.
Our Recommendation
Start with mutual funds when you are a beginner in investing, so that you don't lose the time leverage advantage of an early starter...but parallely keep investing small amounts in stocks and keep learning...give your learning 10 years and then go stock picking...that's the ideal mix...
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The book "From the Rat Race to Financial Freedom" has many such investment tools explained in a very simple and uncomplicated manner.
Cheers
Manoj Arora
Freedom can buy you.... what money cannot !!
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