When it comes to investments, there are many fundamental differences between mutual funds and stocks.
Right from the Return on Investment and risk, both instruments differ in investment style and management. As an informed investor, you should be prudent enough to know these differences before making an investment decision.
This article helps you understand the differences between stocks and mutual funds and also gives you the reason as to why investment in mutual funds is better than stocks.
Difference Between Mutual Fund and Stock Investment
When you buy a share, you get legal ownership in the company with voting rights along with the entitlement to a share of the profits earned by the company. You can also participate in the Annual General Meetings and correspond with the company.
Buying stock, however, is direct participation in the Stock Market, the earnings from which can be in two ways:
- Dividends received and,
- Sale of stocks
When you invest in mutual funds, you get a share in the pooled fund collected by several investors. Your share is the number of units of mutual funds you purchased during the investment. Your rights and benefits are restricted to the mutual fund house.
While investing in stocks, you can lay hands on equity as an asset class but in case of mutual funds, it can be investing in one or more asset classes or sub-asset classes because mutual fund schemes can hold a diversified portfolio.
Investing in mutual funds is in-direct participation in the share market.
In mutual funds, you can earn only through the sale of units and the dividends received on shares of the scheme may or may not be directly available to you.
If you have selected the “Dividend” option, then the fund house shares the dividend received. In case you have opted for the “Growth” option, then the dividends are reinvested in the fund to generate returns.
Mutual Fund Vs Stock Investment
1. Risk and Return
Individual stock purchases are a high risk - high return proposition. There is also a chance that you may end up with negative returns.
Even though Equity mutual fund schemes have a higher risk due to the asset class they invest in, they have a diversified portfolio. Any negative returns on a single stock can get compensated by the returns generated by another stock.
Thus, by investing in mutual funds, you end up avoiding scenarios of negative returns.
You solely rely on your research, knowledge, and skills while making an equity investment, which may or may not be adequate in all market scenarios. You may be constrained by tools and resources which could help you manage your equity investment properly.
All of these drawbacks are not present with mutual fund purchases. Mutual fund houses have experienced financial experts who are fund managers and take care of your investments. Additionally, the fund house also has access to all the tools and resources required to manage the funds.
A well-diversified portfolio should include at least 15 to 20 stocks but that might be a huge investment for an individual investor.
With mutual funds, investors with little funds, as low as INR 1000, can get access to a diversified portfolio. Buying units of a fund allows you to invest in multiple stocks without the need to invest a huge amount.
Due to the economies of scale, mutual funds attract lesser transaction costs when purchasing shares and therefore, pay lower brokerages as compared to individual investors.
You can also save the annual maintenance charges on Demat accounts as you do not require it while investing in mutual funds.
5. Investment Style
When you invest in stocks directly, you have to do your own research, based on the knowledge of which you enter and exit the market and devote time in managing them.
The decision of buying and selling rests with you. Hence, you have full control over the investment decision when you invest in stocks, which makes you an active investor as you look to optimize your returns.
In case of mutual funds, you do not have the freedom to choose or transact in stocks or any assets as for that matter, during the time period of investment.
The fund manager does all the investment, tracking and management on your behalf which makes you a passive investor. So if you are new to stock investing and don’t want to spend a lot of time on stock analysis, then mutual funds are the best option for you.
6. Investing / Trading time
Stock can be bought at any time during the exchange trading hours which start from 9:15 a.m. to 3:30 p.m. during which the transactions happen at the existing price.
In case of mutual funds, they can be bought or sold only once and at the day’s end after the NAV is finalized.
7. Tax Benefits
ELSS mutual funds offer you the option to save taxes and can help you save up to INR 1.5 Lakhs under Section 80C of the Income Tax Act, 1961 by investing in tax saving mutual funds,
There is no such option to save tax while investing in stocks.
Why You Should Choose Mutual Funds Over Individual Stocks
1. Professional Management
When you choose to invest through a mutual fund, you are relieved from analyzing, picking, timing, tracking, and managing the purchase. Everything is managed by a qualified and experienced fund manager.
2. No Taxes on Short Term Gains
As an individual, 15% Short Term Capital Gain (STCG) taxes are applicable if you sell the stock before completion of one year from the date of purchase.
Mutual fund entities, however, are not taxed for STCG on the stock sold. The gains are either distributed or reinvested in the mutual fund which ultimately can benefit you as a unit-holder.
But, you need to hold on your mutual fund investment for at least one year to avoid STCG tax yourself.
In order to get a diversified equity portfolio, you need to invest in at least 15 to 20 stocks, which means that you need to make a large upfront investment.
This is where investing through a mutual fund is more beneficial. With INR 1000 of investment, you get a diversified portfolio across assets, meaning that if you are investing in Equity Mutual Funds, you get a diversified equity portfolio.
4. Lower Cost
Mutual funds work on the economies of scale while buying and selling. They even negotiate with brokers to get better rates, all of which lead to lower costs while the benefits are indirectly passed on to the unit-holders.
This is not in the case when you buy shares. Plus, you do not have to maintain a Demat account when you invest through mutual funds.
We hope you now have some clarity on mutual funds vs stock, and which is a better investment option. If you want to benefit from the inflation-beating returns generated by equities without many of the drawbacks of direct equity investing, but are constrained by time and expertise then, the best way to earn those returns is by investing through mutual funds.