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Where to invest? Direct equities or mutual funds

There are no second thoughts about equities, when it comes to long-term investing. Equities have outperformed all other asset classes and it is a well-proven fact that is backed by data. Just have a look at the table below and you will know why:

post-tax returns of asset classes

Once you are convinced that equity is your best bet for long-term wealth creation, you have two choices:

  • Investing directly in stocks.
  • Investing through mutual funds (MF).

Now both modes have their own inherent advantages and disadvantages. So in order to make the correct choice between direct investing and MF investing (or maybe both), it’s important to understand the nuances of both.

Direct Equities

As far as investing directly in stocks is concerned, it’s not as easy as what many of your friends might claim. They might have been lucky to make some money here or there in markets. But it is tough to beat markets consistently. Choosing the right stock needs skill to analyse the business, sector, competitors and economy as a whole. It also requires to have a basic understanding of financial accounting to correctly read the balance sheets, profit and loss accounts, etc. of companies.

To be honest, most people lack this skill. And for the few, who may possess it, time becomes a crucial factor. A common working professional doesn’t even have time to spend with his/her family. And here we are talking about finding time to do financial analysis of businesses in free time. Seems far-fetched!

It is here that mutual funds come into the picture. An option worth considering for those who want to benefit from the power of equity investing, but do not have the time and/or skill to do it.

Mutual Funds

A mutual fund is a well-diversified group of stocks that are managed by professional fund managers. These managers have a research team at their disposal to analyse and value businesses. As far as the issue of having specialized skills is concerned, mutual funds take care of that part.

Next comes the issue of diversification. When you put all your money in just few stocks (direct stock investing), there is a considerable downside risk, even if one of the portfolio stocks decline. A mutual fund on other hand holds more than 30-40 stocks (generally) and hence, avoids the danger of going down substantially even if few stocks do badly.

A lower degree of diversification in individual stock picking also means that volatility will be high. On a given day it can even be +20% or -20%. If you are not ready to accept such degrees of volatility, then you should seriously give second thoughts about going in for direct equity investing. On the contrary, MFs can be your better bet.

Talking of diversification, MFs also allow investing in other asset classes like debt, gold and even international stocks. This asset-diversification is not possible in individual stocks.

A small investor generally does not have a lot of money to invest. So when it comes to achieving adequate diversification, it’s tough if one has small amounts to invest directly in stocks. Example – There are many good stocks trading at more than ₹15,000 per share. So putting in place a well-diversified portfolio of good shares will require a lot of money. But mutual funds allow one to invest as less as ₹500 and take exposure to a portfolio of 30-50 stocks.

Another benefit of going for mutual funds is that it allows for systematic investments through SIP. No such automatic facility is available in stocks. Though one can still do it manually, it’s a cumbersome activity to carry out every month.

What to do?

Now that we have already discussed major differences between the two modes, I’m sure you would be much clearer about the option that suits you the best. Of course, individual stock picking has the potential for massive and quick returns (at times, overnight). But picking the right stock also requires a lot of skill and time. And chances of getting the stock pick wrong, is always there. MFs on the other hand are not going to double overnight. But they also provide downside protection due to diversification and hence, reduce the risk.

So as far as the question of which mode is better for you is concerned, the best person to answer that is You.

Disclaimer: The facts, views and opinions expressed within this article are personal opinions of the author and do not reflect the views of BigDecisions. We do not assume any responsibility or liability for the same.

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