Here's an interesting fact about India.
Compared to other countries, individual investors in India hold more stocks in their name, than they hold mutual funds.
Only about 3% of the total market cap in India is held through equity Mutual Funds, whereas direct holding by individuals is nearly 22% of the market (7 times more); contrary to the developed markets where individual investors tend to hold stocks primarily through Mutual Funds.
The question for an individual is then, why buy equities through a Mutual Funds (and land up paying annual fees of ~ 1.8% of the total Assets), when they can buy directly through a stockbroker (paying a one-time per trade charge).
Here are a few reasons to buy mutual fund instead of stocks
#1: You are not held back by your ability to pick and track stocks
One of the main benefit a Mutual Fund provides is that you don't have to pick stocks. Picking stocks, tracking them, making sector and asset allocation, buying and selling stocks when required, are all best done by a professional fund manager.
We have seen several individuals who bring up their old portfolios for review. The older portfolios, say more than 15 years old, have more than 60% of stocks that are completely defunct today. Such defunct companies drag overall portfolio returns even though the other stocks may have done well. Recently, I saw a portfolio that is a 60 year old portfolio and not even one company exists today.
In a Mutual Fund, you can avoid such situations completely. It’s managed by a professional fund manager who’ll ensure your portfolio contains good stocks with potential for long term returns.
#2: Zero capital gains tax for short-term profit booking by the fund manager
When an individual manages a portfolio of stocks, there will most likely be some selling and buying. If the selling of stocks is done within one year of purchase, there is an incidence of short term capital gains tax.
Whereas for a fund manager, there is no capital gains tax, even if it were to book short term capital gains for the fund he manages. This will trickle down as benefits for you as an investor in that fund.
That being said, if you invest Rs 10,000 in a particular equity mutual fund and after 3 months, the value becomes Rs 12,000 and you withdraw the entire amount, you are liable to pay tax on the Rs 2,000 profit. Only after a year does withdrawal from equity mutual fund not attract any tax.
#3: Lower cost associated with investing
The fund, being large, will be able to benefit from economies of scale. It can negotiate better with intermediaries, and therefore lead to lower overall costs.
For e.g. if you were to open a share trading account, you’ll probably end up paying 0.5%-1% of the trade as commission to the brokerage. However, due to the scale mutual funds have, they’ll end up paying much less than that. This benefit will indirectly be passed to you as a mutual fund investor.
SEBI, the market regulator, has made it compulsory for the management fees to include all associated costs. Look out for the expense ratio of funds to understand the cost of investing. This is a % value that tells you how much the mutual fund charges you as fund management fee.
Expense ratio is typically around 1.8% for actively managed equity funds.
#4: Instant diversification of your portfolio with a few thousand rupees
Typically, in order to have a well balanced portfolio, you would need to have about 25-30 stocks in your portfolio. This can lead to a good mix of performance and stability.
Such a basket approach can be achieved if you have a large enough corpus. As an individual, you may not have sufficient funds or mental bandwidth to create a sufficiently diversified portfolio of stocks.
Mutual funds provide instant diversification. Since you are buying units of the mutual funds that are spread across several stocks, you receive diversification benefit without investing a huge corpus.
#5: More time to do what you love
You may be expert in your own field. For example, you may be a great programmer or a sales person. Stick with your area of expertise, and what you love doing. You will probably end up earning more, if you stick with what you love doing.
Leave investing to specialists, who know and love what they do.
More time at your disposal also means you get to do more of what you love to do the most outside of work- like taking a vacation or spending time with your family.
#6: Mutual fund investing is simply more convenient
With stocks, you have to open a DEMAT and a share trading account, do complex analysis on companies and sectors to understand which stock to buy, know when to sell stocks, pay commission on each trade you make, and more.
When a Mutual Fund is managed, a custodian will handle all settlements and safety of assets. It is the job of the custodian to ensure settlements happen safely and investor assets are secured. It’s also a tightly regulated industry.
Everything gets done for you for a very small management fee. Online platforms like Scripbox make it even easier to invest in mutual funds by doing fund selection, annual portfolio review, automated investments and more for you, completely online.
All these being said, we are not saying you should never directly invest in stocks. Direct stock investing can be profitable and worthwhile if you
- Are willing to spend time analysing and tracking companies and sectors regularly
- Can handle volatility on a more frequent basis
- Understand tax implications of your trade, especially if you do volume trading
- Have enough money to invest in building a diversified portfolio of stocks
For someone who wants their money to grow safely, generating inflation-beating returns, and not having to worry too much about where and when to invest, a mutual fund offers a good alternative.