Equity shares are a good choice for creating long term wealth. Long term earnings growth from the underlying company translates to a share price rise which in turn benefits equity investors. Thereby, creating wealth.
The opposite can happen too when a company does badly, instead of profits, losses get accumulated; you will then find the share price falling and eroding your wealth. Hence, there is risk.
You can either buy shares directly or through equity mutual funds. In a mutual fund, you entrust the responsibility to a professionally qualified fund manager to build an adequate portfolio of equity shares.
Which is better – direct shares or mutual funds? Ask yourself these two questions.
Can you analyse business fundamentals?
Investing in equity shares requires you to find answers to many questions related to the underlying company. Will it be able to continue selling its product or service at a profit? To grow their market will they need to take on debt, and if so, how much debt? Is the management capable of managing growth? And so on.
You should also be able to pull out the financial statements, its balance sheet, profit and loss statement, compare financials across time periods and infer whether the company is of sound financial health.
Lastly, you have to analyse whether the share price in the market reflects the financial health and future earnings along with its management quality. Is the price over compensating for the positives, and thereby, expensive or is it yet to reflect all the positives and is available cheaply.
Undoubtedly, these are tough technical questions. Don’t be alarmed if you can’t answer any, you are not expected to. It is the job of qualified fund managers to look for these answers and filter down from a selection to a few stocks that fit into a neat portfolio. If things go wrong, fund managers sell the shares and switch to another company.
Your time and diversification
Sometimes because of the nature of your work or the industry you work in, there exists an ability to answer many of these questions accurately.
However, even if you know a company inside out it is not rational to have all your long-term investments in shares of that one company. That would be too risky. To diversify and reduce risk, you should look at adding managed portfolios to your existing shareholding if any.
Secondly, you may have the answers, but may not have the time to keep tracking changes and updating these answers accurately. Once again, take the help of managed portfolios like mutual funds to balance your equity exposure.
Equity fund managers are qualified professionals whose job it is to analyse the financial health of a company and understand its future earnings capacity. For most investors equity mutual funds will be a simpler, more efficient, and a lower risk choice as compared to direct equity.