Investors, especially beginners, often wonder whether shares or mutual funds will be a better investment vehicle. In this article, we will try to answer the queries related to the topic. Check the FAQs.
I’ll try to be as direct as possible to highlight the differences between mutual funds and shares.
To decide between shares or mutual funds as to which vehicle is better, we must first understand who asks the question.
- For pro investors in the stock market, undoubtedly, shares are better.
- If the people in consideration are retail investors, for a majority, the mutual fund is a better choice.
But this is not the final answer. It is just a generalization. I’ll explain the pick between shares or mutual funds in more detail. Then one can decide their preference.
It is logical for beginners to get confused between picking shares and mutual funds. But many eventually opt for mutual funds as everyone else around them is investing in them. Moreover, people also hear that investing in shares is risky.
But ultimately, everything in investment boils down to these two things – ‘potential returns‘ and ‘risk of loss.’ If the person knows how to manage the risks associated with an investment, then good returns will happen as a byproduct.
The biggest risk associated with stock investing is when one picks stocks of a fundamentally weak company at an overvalued price. People who know how to negate this risk can invest in stocks. But otherwise, Mutual Funds will be a safer alternative.
A similar risk is also associated while investing in equity-based mutual funds. But this risk is managed by an expert, the mutual fund manager. Investors in a mutual fund scheme need not bother about this risk. Hence, people who do not know stock analysis should stick with mutual funds.
Comparison Between Shares and Mutual Funds
For a person who likes to invest passively, a mutual fund will be more suitable. For a person who likes to stay involved with his/her investments, stocks will be suitable. The time required to research stocks before picking one for investment is a time-taking activity. In mutual fund investing, the time spent on research is not as high as on stocks.
Let’s try to understand it through the back-drop of the process of investing. Generally speaking, there are four stages of an investment process:
The Investment Process
- Investment Research: It starts with the screening of suitable security. The decision-making could be about whether to invest in equity, debt, real estate, or gold. Furthermore, one can use online screeners to filter their stocks or mutual funds. But after the screening, a more detailed analysis is a must. This process is lengthy and not easy. In direct stock investing, one must take care of these steps by self. While in Mutual Funds, the fund manager does it for us.
- Picking & Buying an Asset: After investment research, the next step is to buy security among what was analyzed. In the case of direct stock purchase, the investor can invest online by themself to buy stocks. But to do it, one will need a Demat account, a trading account, and an online banking account. They all come at a price. In the case of mutual funds, no Demat and trading account is necessary.
- Portfolio Building: The main task to be done in portfolio management is ensuring diversification and portfolio rebalancing. Both these are demanding jobs, especially for an individual investor. Why? Because to diversify, one will need to buy several stocks of non-related sectors. It is both pricy and difficult to execute. But in the case of mutual fund investment, diversification and rebalancing is done by the fund house at their cost.
- Redemptions: When we are dealing in shares, timing the sale of stocks is as important as timing their purchases. If one has many stocks in their portfolio, timing the sale at times becomes tricky. Though, mutual funds can use software to time the sales.
In terms of the process of investing (or ease of investing), it is clear that mutual funds look inviting. Mutual fund investment can be practiced almost passively. But in the case of direct stock investing, personal involvement is more dominant.
But I’ll like to highlight the most critical aspect of the above comparison. People should not opt for mutual funds because of point number 2, 3, or 4. They must do it for point number one. If one does not know to do a detailed analysis of stocks, one should go for mutual funds.
How to do a detailed analysis of stocks? The method of stock analysis starts with reading financial reports of companies. Any listed company will have to issue an annual report. The annual report consists of a balance sheet, profit & loss account, and cash flow statement. A good stock investor knows to read and comprehend these reports.
Potential Returns: Stock vs Mutual Funds
Till now, what we have read weighs in favor of mutual funds. So does it mean that direct stock shall be the second choice of common men? The answer is both Yes and No. Why?
Stocks will be the second choice for people who do not know how to read and analyze financial reports. We can also say that people should stay away from stocks if they have no ways to do a detailed stock analysis. Note: Do stock analysis using our Stock Engine.
But if one can analyze stocks, then investing in shares will be the first choice. Why? Because through analysis, one can pick Multibagger stocks that can yield much higher returns than mutual funds.
Check the comparison shown above between returns generated by top stocks and top mutual funds. I’ve considered both stocks and mutual funds from the large-cap space to maintain parity. In a time span of 10 years, the average return generated by the top 10 stocks shown above is about 30% per annum. In the same period, the average return generated by the top 10 mutual fund schemes is about 13% per annum.
As you can see, the potential reward of investing directly in stocks is huge. Hence, the benefits of investing in stocks post a proper and detailed analysis is worth a try.
Just for the sake of comparison, check what it means by 30% and 13% per annum returns. Suppose you bought two investments today for Rs.1,00,000 each and held them for the next 10 years. One is expected to yield a return of 30% p.a. and the other 13% per annum. Let’s see how much will be the final corpus after 10 years from today:
The investment growing at 30% per annum will grow by 13.78 times in a holding period of 10 years. Simultaneously, at 13% per annum returns, the investment will grow by only 3.4 times in 10 years.
You are still confused about whether to invest in shares or mutual funds? I suppose not. Anyways, you can also check these FAQs. It will further clear any doubts.
For the majority, Mutual Fund is the vehicle suitable for them. Why? Because of their lack of know-how about stock analysis. Even if they have an interest, they do not have the spare time to learn it.
In case you want to enjoy the benefits of shares and the safety of mutual funds, you can try the Exchange Traded Funds (ETF = Stocks + Mutual Funds). ETFs, come as a package that has the versatility of stocks and the safety of mutual funds.
I remember my first purchased stock during the turmoil of the financial crisis of 2008-2009. It was DLF. I could make double-digit returns within a few months. But the luck did not last for long. As the Sensex touched back its 20,000 level by Oct’2010, my luck began to fade. It was the result of investing in stocks without proper research.
When the market is recovering (like it is doing now post-COVID), it is easy to make money in stocks and feel confident. But I know that this euphoria and overconfidence will fade soon.
These days almost any Stock, if held for a few months, is rendering double-digit returns. But making money from Stock will always not be so easy. Hence, it is better to become cautious and switch sides now. It’s time to do it. Else, if you want to continue investing in stocks, learn to analyze them in detail. Suggested Reading – The concept of intrinsic value.
No. Shares represent proportional ownership of the shareholders in a company. For example, if there are a total of 100 shares of a company and you hold 2 numbers, then your ownership in the company is 2%. Equity-based mutual funds hold shares of several companies in their portfolio. By buying a unit of a mutual fund, we are actually buying a piece of that portfolio. Even if one holds several units of an equity fund, he/she is not a shareholder of any company.
For a passive investor with little know-how about stock analysis, mutual funds are suitable. Here, the portfolio management is done by the fund manager. An active investor, who can do a fundamental analysis of stocks, can invest in shares directly.
Mostly, a bad investment decision makes shares risky. How? In two ways. First, buying shares at overvalued price levels is a bad decision. Second, buying shares of a low-quality company. Judging the price and quality aspects of a stock is not easy. This makes shares investing risky. In mutual funds, investment decisions are made by the expert fund manager. Hence, comparatively, they are less risky. No, equity mutual funds are not risk-free.
Yes. If one does not have time for stock research, portfolio tracking, etc, mutual funds are certainly a better investment vehicle. Moreover, the portfolio of mutual fund schemes is more diverse than an individual’s portfolio.
Generally, a good equity mutual fund can yield a return of 12-18% per annum in a long term. A good stock bought at undervalued price levels can yield returns of 20%+ per annum if held for a very long term. In direct stock investing, the long-term holding means 5-7 years minimum.
Yes. Exchange Traded Funds (ETFs) are such an investment option. Read more about it.
When the holding time is as long as 10 years, equity (like shares, and equity funds) is more suitable. But out of shares and mutual funds which is more suitable? For people who are not conversant with stock basics, mutual funds are better. But for informed investors, share investing can yield above-par returns, much higher than the average return of the market.
For a trader, mutual funds are certainly not the right pick. For a day or short-term traders, stocks will be the right alternative. They can also do Futures & Options trading. Trading in ETFs is also possible.
Mutual funds operate under the regulations of SEBI. Hence are safer for retail investors. In India, mutual funds are mostly trustworthy. If one has an appetite for higher risks, one can invest in stocks for higher returns. For retail investors, at present Cryptocurrency like Bitcoin is not suitable as they have still not come under the regulatory framework.
SIP is a way to invest in mutual funds schemes. For passive investors, who do not have time or know how to do stock research, SIP will be better. Moreover, SIPs also yield the benefit of Rupee cost averaging. Direct investment into the share market is for people who know the rules of stock investing.
Generally speaking, equity mutual funds are less risky than stocks. Debt funds are even safer, they are suitable for risk-averse investors. Mutual funds are safer for two main reasons. First, their portfolio is managed by expert fund managers. Secondly, their portfolio is much better diversified.
Reading Next: Stock vs Other Investment Options
Have a happy investing.
Thanks for sharing such an amazing and informative blogs.
Keep it going.
all the Best