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Praveen Gurwani
The Investors biggest Dilemma
Mutual Funds or Stocks? That is the biggest decision for an investor in India today. Read this article before making a choice that may be wrong for you.
The Indian equity market is on the roll for the last 2-3 years. The future too looks quite promising with GDP growth projected at 8-10% for the next few years. This superior return expectation is, therefore, attracting a whole lot of new investors – both domestic and foreign - to the equity markets.
A typical dilemma for an investor today is whether to directly buy stocks or alternatively invest through the mutual funds.
The key to answering this dilemma lies in appreciating the differences between the two routes and deciding as to which one is more suited to one’s knowledge & understanding, investment objective, risk appetite and personal profile.
Active vs Passive style
Direct investment into stocks is an active form of investment. You do your own research and decide which stocks to buy, when to buy, when to sell etc. You have a control over the investment decisions. It is more fun and challenging. Managing your own portfolio would, however, require you to commit a fair amount of time and effort. Moreover, considering the dynamic nature of businesses and stock markets, almost a daily involvement is necessitated. Else you may miss the opportunity to either buy or sell at the right time.
In contrast, Mutual Fund investing is a passive form of investing. You hand over your money to the fund manager and he manages your money alongwith that of the others. With this all the responsibilities of investment decisions and day-to-day management are handed over to a professional. You need to only periodically check the performance of the fund. And depending on whether it meets your expectations or not, you either let him continue to manage your funds or switch over to some other better performing funds.
Skill set
Managing one’s own portfolio requires a sufficient level of knowledge and expertise. Not many of us would have the educational qualifications, the knowledge and the experience of that of a typical fund manager. Even if one had sufficient time, money and resources at one’s disposal, it may be difficult to consistently match the performance levels of a professional fund manager.
Therefore, many a times it may be prudent to depend on the expertise of the fund manager.
In addition, a mutual fund would pool in different skills – a research analyst to identify stocks, a fund manager to decide on investment strategy, back-office to manage all the associated paperwork, etc. This support structure may be lacking when managing on one’s own.
Diversification
Not all businesses or sectors will perform equally. Not all companies would be equally efficient. Therefore, owning ‘few’ stocks exposes an investor to high level of business and market risk. Even a poor performance of 1-2 stocks can significantly affect one’s overall returns. (Also read - Risk a little and Gain a whole lot)
A mutual fund enables an investor to achieve a fairly high degree of diversification, which is difficult to achieve by buying into individual stocks unless one has a fairly large corpus. This helps to minimize risk, as a loss in a few stocks will not dampen the returns too much. There is a relative safety in numbers.
Though of course there is a downside to too much diversification. The excellent returns from say some multi-baggers can be undone by the average performance of the other large number of stocks in the portfolio.
Regulatory issues
Mutual funds are bound by certain regulations, which may sometimes be a hindrance to the performance of the fund.
For example a fund cannot invest more than a certain % in a particular company. Therefore, if there were a great opportunity to invest in, the mutual fund would be restricted to invest only a certain amount in it and the balance may have to be invested in a comparatively lesser performing stocks.
Or say a fund cannot invest in a good small cap stock as the same does not meet the investment criteria as yet. It would be able to invest only after it has achieved a set level of performance, by which time the stock may have already run-up and hence an opportunity loss to the fund.
Corpus size
Investing in equity requires a fairly large amount of money. On the other hand, mutual funds allow us to participate in the stock markets even with very small amount say Rs.1000 or so, which would not be possible in direct investing.
Hence, if one has limited capital but wants to take advantage of the equity markets, mutual fund may be the better choice.
Management fee
Mutual funds charge an annual fee, which is a generally about 2.5% of the corpus they manage. This is deducted from the corpus itself and the NAV is a reflection of the post-expenses unit value.
No such fees is payable if you are directly owning the stocks except maybe a nominal fees charged by the depository.
Hence, if you hold your investment for a large no. of years, the overall returns from a mutual fund would be a bit lower than managing your own portfolio, all other things remaining the same.
Liquidity
Generally the liquidity may not be an issue whether one invests directly or through a mutual fund. However, with some stocks there could be an issue sometimes if it is a thinly traded scrip.
Convenience
Apart from being easier to monitor, the mutual funds are relatively easier to manage vis-à-vis equity investments. One doesn’t need a demat account. One can buy/sell the units directly from/to the Mutual Fund without depending on a broker, whom we need if we are to buy/sell shares.
Also, the mutual funds send regular reports pertaining to ones investment, which contains all the details we may need for assessing our income and tax liability, if any, thus reducing our paperwork.
Having looked at the pros and cons of each of the investment options, we can make our choice based on one’s comfort level.
One could of course also partly invest through mutual funds and partly directly. This would enable us to say enjoy the expertise, stability and security offered by a mutual fund and also try one’s luck with some unknown/lesser known stocks which may have the potential to become multi-baggers.
:tea:
The author is Sanjay Matai, Investment Adviser.
Mutual Funds or Stocks? That is the biggest decision for an investor in India today. Read this article before making a choice that may be wrong for you.
The Indian equity market is on the roll for the last 2-3 years. The future too looks quite promising with GDP growth projected at 8-10% for the next few years. This superior return expectation is, therefore, attracting a whole lot of new investors – both domestic and foreign - to the equity markets.
A typical dilemma for an investor today is whether to directly buy stocks or alternatively invest through the mutual funds.
The key to answering this dilemma lies in appreciating the differences between the two routes and deciding as to which one is more suited to one’s knowledge & understanding, investment objective, risk appetite and personal profile.
Active vs Passive style
Direct investment into stocks is an active form of investment. You do your own research and decide which stocks to buy, when to buy, when to sell etc. You have a control over the investment decisions. It is more fun and challenging. Managing your own portfolio would, however, require you to commit a fair amount of time and effort. Moreover, considering the dynamic nature of businesses and stock markets, almost a daily involvement is necessitated. Else you may miss the opportunity to either buy or sell at the right time.
In contrast, Mutual Fund investing is a passive form of investing. You hand over your money to the fund manager and he manages your money alongwith that of the others. With this all the responsibilities of investment decisions and day-to-day management are handed over to a professional. You need to only periodically check the performance of the fund. And depending on whether it meets your expectations or not, you either let him continue to manage your funds or switch over to some other better performing funds.
Skill set
Managing one’s own portfolio requires a sufficient level of knowledge and expertise. Not many of us would have the educational qualifications, the knowledge and the experience of that of a typical fund manager. Even if one had sufficient time, money and resources at one’s disposal, it may be difficult to consistently match the performance levels of a professional fund manager.
Therefore, many a times it may be prudent to depend on the expertise of the fund manager.
In addition, a mutual fund would pool in different skills – a research analyst to identify stocks, a fund manager to decide on investment strategy, back-office to manage all the associated paperwork, etc. This support structure may be lacking when managing on one’s own.
Diversification
Not all businesses or sectors will perform equally. Not all companies would be equally efficient. Therefore, owning ‘few’ stocks exposes an investor to high level of business and market risk. Even a poor performance of 1-2 stocks can significantly affect one’s overall returns. (Also read - Risk a little and Gain a whole lot)
A mutual fund enables an investor to achieve a fairly high degree of diversification, which is difficult to achieve by buying into individual stocks unless one has a fairly large corpus. This helps to minimize risk, as a loss in a few stocks will not dampen the returns too much. There is a relative safety in numbers.
Though of course there is a downside to too much diversification. The excellent returns from say some multi-baggers can be undone by the average performance of the other large number of stocks in the portfolio.
Regulatory issues
Mutual funds are bound by certain regulations, which may sometimes be a hindrance to the performance of the fund.
For example a fund cannot invest more than a certain % in a particular company. Therefore, if there were a great opportunity to invest in, the mutual fund would be restricted to invest only a certain amount in it and the balance may have to be invested in a comparatively lesser performing stocks.
Or say a fund cannot invest in a good small cap stock as the same does not meet the investment criteria as yet. It would be able to invest only after it has achieved a set level of performance, by which time the stock may have already run-up and hence an opportunity loss to the fund.
Corpus size
Investing in equity requires a fairly large amount of money. On the other hand, mutual funds allow us to participate in the stock markets even with very small amount say Rs.1000 or so, which would not be possible in direct investing.
Hence, if one has limited capital but wants to take advantage of the equity markets, mutual fund may be the better choice.
Management fee
Mutual funds charge an annual fee, which is a generally about 2.5% of the corpus they manage. This is deducted from the corpus itself and the NAV is a reflection of the post-expenses unit value.
No such fees is payable if you are directly owning the stocks except maybe a nominal fees charged by the depository.
Hence, if you hold your investment for a large no. of years, the overall returns from a mutual fund would be a bit lower than managing your own portfolio, all other things remaining the same.
Liquidity
Generally the liquidity may not be an issue whether one invests directly or through a mutual fund. However, with some stocks there could be an issue sometimes if it is a thinly traded scrip.
Convenience
Apart from being easier to monitor, the mutual funds are relatively easier to manage vis-à-vis equity investments. One doesn’t need a demat account. One can buy/sell the units directly from/to the Mutual Fund without depending on a broker, whom we need if we are to buy/sell shares.
Also, the mutual funds send regular reports pertaining to ones investment, which contains all the details we may need for assessing our income and tax liability, if any, thus reducing our paperwork.
Having looked at the pros and cons of each of the investment options, we can make our choice based on one’s comfort level.
One could of course also partly invest through mutual funds and partly directly. This would enable us to say enjoy the expertise, stability and security offered by a mutual fund and also try one’s luck with some unknown/lesser known stocks which may have the potential to become multi-baggers.
:tea:
The author is Sanjay Matai, Investment Adviser.