Mutual Funds Versus Stocks
One of the standard dilemma or choice that investors have to make is whether to invest directly in equities or through the route of equity mutual funds. Frankly, there are no clear answers. However, we can adopt a question approach and ask some logical questions to arrive at this decision.
Do you have time and bandwidth to track investments?
This is the most important question to ask. Investing in equities is not just about buying equities based on advice given. It is always that you should be your own investors. That means, you must conduct your own analysis, ask the right questions and also monitor the portfolio. If you think that you can spend the requisite time and you also have the bandwidth to do all that then you can seriously look at investing directly in equities.
Of course, there is the issue of skill-sets needed when it comes to selecting equities and in monitoring them. Remember, you do not just need to understand the stock, but the company behind the stock and also the dynamics of the industry and the macros. Nowadays, there is a lot of news flow about corporate actions, quarterly results, management changes, inorganic growth etc. All these need to be tracked.
Does direct equity makes sense for a small corpus?
It is your choice ultimately, but frankly if the corpus is small, it may make sense to just stick to good equity funds. Investment is all about spreading your risk and that is normally done through diversification. Fund managers do it quite well. If you want to do that on your own, then you will need a much bigger investable capital. For example, to spread your portfolio across 10-12 stocks with economies of scale, you need a lot of money.
On the other hand, mutual funds pool money on behalf of investors and then manage the money on behalf of thousands of investors. With a larger combined corpus, they are in a much better position to spread the risk. As a mutual fund-holder, you indirectly get the benefits of diversification through your proportionate ownership in the asset base.
Will you focus on just stocks or are you looking at themes?
What exactly does this mean? If you want to focus on a handful of stocks that you understand then direct equities may work perfectly well for you. For example, if you have been in the steel industry for 20 years and want to buy steel stocks, you are equipped to take a rational and well thought out decision on your own. Direct equities will suit you.
However, if you are looking at larger themes in the market, then MFs may add more value. If you want to participate in the India story overall or in the consumption or digital stories, then mutual funds will offer a better platter. If you are looking at bigger themes with smaller investment allocation, mutual funds may be the answer.
However, if you are looking at larger themes in the market, then MFs may add more value. If you want to participate in the India story overall or in the consumption or digital stories, then mutual funds will offer a better platter. If you are looking at bigger themes with smaller investment allocation, mutual funds may be the answer.
Is your purpose of investing, long term wealth creation?
Investors often argue that as you do SIP on mutual funds, you can also do SIP on equities. That is where stock selection becomes very critical. For example, if you had consistently created an SIP of real estate stocks or capital goods stocks in the last 10 years then most likely you will be sitting on negative capital value.
However, the story would have been very different if you had done this SIP on automobiles or private banks or IT stocks. An easier method will be to undertake this SIP through a diversified mutual fund. You have enough empirical evidence to substantiate that an SIP on equity funds works effectively and with much lesser hassles. They also aid long term wealth creation.
Do you plan to invest for long term goals like retirement?
Anything has a purpose and it is essentially to know where you are going. If you don’t know where you want to reach, it does not matter how fast you run. Normally, you buy equities or mutual fund units as part of a larger investment plan. You want these investments to work hard enough for you to help move towards your long term goals.
The key point to note is that if you are looking at a serious sync with your goals then mutual funds work better that direct equities. Your long term financial goals are largely based on sound risk management and that can be achieved through mutual fund investments as there is natural diversification built into them.
Does tax efficiency make a difference to choosing equity versus MFs?
Actually, not much. Today, from the dividend and the capital gains point of view, there is not much of a difference. In both the cases, the dividends are now fully taxable as other income in the hands of the investors. Also capital gains, both STCG and LTCG, are treated similarly for equities and mutual funds. Hence you can be indifferent.
However, there is one area of difference. For example, if you invest in ELSS schemes of mutual funds, you get an additional rebate under Section 80C, which is not available in case of direct equities. While these are all minor issues, they surely add up to quite a bit in the final analysis. Consider these aspects before making a decision.
Are you confident of leaving things to experts?
Don’t forget that, at the end of the day, investing is a highly specialized job. The dynamics are just too many and it is an area that is in a constant state of flux. Even veteran investors find it difficult to manage their equity portfolios in such a fast-changing environment. If you are not full-time into equities, then directly equities may not give you substantially better results than relying on equity funds.
If you have the confidence to leave to a fund manager and have had a good experience in the past, it is better you leave the finer aspects to a mutual fund. The choice may be quite clear in that case to opt for the comfort and peace of equity mutual funds.