Wealth creation requires skill, knowledge, time and risk taking capability. Investment through long term equity is the ideal strategy to plan for long term goals and beat inflation.
There are two options to invest in equity market – Equity based Mutual Fund and Direct Equity.
Mutual Funds: Mutual fund is a professionally managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities depending on the underlying objective of the scheme.
Stock – Direct Equity: Stock or share is a security that represents ownership in a company. Here money that is invested in a firm by its owner/s or holder/s of common stock (ordinary shares) is recovered when they sell their shareholdings to other investors.
Merits and Demerits of Mutual Funds and Direct Equity
Mutual Fund or Direct Equity – Which one is a better option ?
Mentioned below are various factors which an investor should consider before making his decision to invest in mutual fund or direct equity.
Time to research stocks: Studying the share markets is a full time job and requires lot of time and devotion on part of the investor. If an investor is having adequate time to study markets and continuously monitor his/her investments, it is good to invest in direct stocks.
Market Expertise : Many stock portfolios are very old and could be holding stocks that are defunct today. Such stocks bring down the overall portfolio returns. Thus, an investor requires adequate skills, research and expertise in managing the investments under direct equity.
In mutual funds, one gets the benefit of a fund manager’s expertise. The fund managers have quality access to research material and have excellent skills and experience in managing the fund to the best of their discretion.
Amount to invest: The cost and time involved in research for selecting stocks is not justifiable for small amount of investments because in case of stocks an individual needs to go through financial data of too many companies all by his own. Hence for small investors mutual funds are a better option. The investor gets the benefit of rupee cost averaging too, through investing by SIP (Systematic Investment Plan) in mutual fund which is not available in case of stocks.
Charges : The main charge in mutual funds is the annual expense ratio (fees charged as percentage of total investments).
Charges in stocks are demat, brokerage and transaction charges. More so, if an individual investor trades frequently he/she needs to pay significant brokerage commission and Capital Gain on every transaction.
Diversification: A mutual fund scheme provides the investor exposure to a range of stocks held in the portfolio of the scheme, even for a small amount of money.
In case of stocks, for the same amount, the investor can purchase only limited number of different stocks. One needs to invest a large sum of money to have the same level of diversification as in a mutual fund scheme.
Ownership: Equity share is part of shareholding and involves direct ownership. An investor is thus an owner and have to discharge duties and have the right to share loss or profit.
In case of mutual funds, since the stocks are held indirectly by the investors they do not have any ownership right.
Investment Strategy: Mutual Funds provide various innovative investment and withdrawal strategies to investors like SIP (Systematic Investment Plan), STP (Systematic Transfer Plan), SWP (Systematic Withdrawal Plan) etc. Such innovation help investors to be more disciplined about investments and provide them seamless experience of entering, managing and exiting from funds. Also, portfolios are managed as per various strategies like growth, value, contra etc.
Such investment strategies are not available in case of individual stocks. Further some mutual funds provide various other options and facilities like dividend reinvestment which are not available in case of purchase of stocks.
Control Over Investments: If a person wants control over his investments, he/she should invest directly in stocks. In case of mutual funds, the decision to buy, sell and hold stocks is delegated to the fund manager and the investor has no control over his investments. Thus even if one knows that markets may fall, nothing cannot be done.
As is evident from the discussion above, both mutual funds and direct equity have their own pros and cons.
How and when investors can get more from mutual fund plans
Direct equity investing , a more dynamic way of investing is feasible only for those investors who are able to understand the dynamics of equity markets and have the time to track it regularly.
However investors who are not skilled to understand the working of the equity markets or have limited time to monitor investments should choose the indirect route of mutual funds. For a small fee, the investor gains from the stock-picking ability of the professional fund manager and does not have to spend time to track the portfolio.
Reasons to validate why the fund route can be better
Taxation : When an individual investor buys and sells shares before completing one year, he ends up paying short term capital gains. However the fund managers may keep transacting in shares at varying intervals. If an investor remains invested for more than one year in an equity mutual fund, his gains are tax free since securities transaction tax (STT) is already deducted.
Lower cost of investing : A person dealing with direct equity has to pay 0.5-1% as brokerage and demat charges.
However, due to their scale, mutual funds pay only a fraction of the brokerage charged to individual investors. This benefit gets indirectly passed to one as a mutual fund investor. Also there is no need to open a demat account.
Instant diversification : A well diversified portfolio should have about 25-30 stocks which can be created only with a large corpus. An individual may not have sufficient funds for a diversified portfolio.
Mutual funds provide instant diversification by way of investing across several stocks without investing a huge corpus.
Liquidity : Open-ended mutual funds allow investors to exit at the prevailing NAV subject to exit loads. This helps in financial planning. In case of an individual investing in shares, he/she is not sure if the shares can be sold in the market at fair value.
Risk Management: An individual may get carried away and go overboard while investing in a particular stock. A fund manager will not do so since because of many risk management guidelines in place under which limits are prescribed on how much a fund manager can invest in each stock and each sector.