Often investors are confused whether they should directly invest in stocks or invest through mutual funds for equity investment. Mutual funds invest the pooled money from investors in publicly traded stocks known as equity mutual funds. On the other hand, these stocks (direct equity) can also be purchased directly through the stock exchange. Historically, investment in direct equity has given both massive gains and massive losses to certain investors. Here, in this article, we will understand the difference between direct equity vs equity mutual funds.
What is a Direct Equity Investment?
Direct equity investment refers to investment in the stock market directly where an investor receives shares of a company. A share is an indivisible unit of capital that shows the investor’s relationship with the company’s ownership to get voting rights. A stock market is open to everyone.
You can view the equity stock price movements anytime (the price moves happen within trading hours, though). For instance, if you invest in a company that makes a profit, the stock price might increase (but not necessarily as it is only one of the factors that influence stock prices). As a result, you will also make a profit on your direct equity investment.
The process of investing in direct equity is simple these days. All you need is to open a demat and trading account to buy and sell shares. The demat account can be personally managed, or a broker/dealer can manage it on your behalf. Moreover, investors who are well equipped to understand the working of equity markets can directly purchase stocks. Also, they can understand the balance between risk and returns. Hence, investing in direct equity requires expert’s guidance if you do not have the time or adequate knowledge.
What is an Equity Mutual Fund?
Equity mutual funds are open-ended funds where money pooled is invested in shares and stocks of different companies. In other words, equity mutual funds invest in shares on your behalf. The percentage of equity asset allocation depends on the scheme objectives. The net asset value (NAV) of the fund fluctuates based on the market movements. In simple words, NAV is the price for the mutual fund investment.
Investing in equity mutual funds has the advantage of professional fund management. Here, the fund managers decide whether to buy, sell or keep the assets in the fund. Moreover, investors also get the benefit of liquidity where they can withdraw from the fund anytime. Also, several types of equity mutual funds fit the investor’s objectives based on their investment horizon and risk tolerance levels. Furthermore, you can start with a minimum investment of INR 500 in mutual funds.
Direct Equity vs Equity Mutual Funds Know the Difference
The following are some of the key differences between direct equity and equity mutual funds –
Not every investor has the necessary skills to identify the right stocks. Nor can everyone dedicate time to do research. Investment in direct equity requires adequate skill and knowledge. In contrast, equity mutual funds offer investors the expertise of fund managers.
Investing in direct equity is considered riskier than equity mutual funds, and investors in direct equity tend to be more active in taking risks. At the same time, equity mutual funds have risk management guidelines in place. The fund manager may not go overboard on a particular stock.
Individual stocks are more volatile in nature. The value of each stock might rise or fall within a very short span of time, thus leading to massive profits or losses. However, an equity mutual fund is a portfolio of stocks that is more diverse and stable. Thus, equity mutual funds are less volatile as it is spread over a wide range of stocks.
The mutual fund charges fees for their services (E.g., fund management charges) in terms of expense ratio. This charge is capped under the regulation. For direct equity, the cost involved is for opening and maintaining the demat account. Also, the STT (Security Transaction Cost) charges for the trading of shares. Therefore, investors must be aware of these charges before they plan to invest.
Equity mutual funds allow investors to exit from the fund anytime at the prevailing NAV, subject to exit load. On the other hand, if an investor invests in direct equity, they are not sure if they can sell the shares in the market at a fair value or not. Sometimes the investment value in these shares might also turn negative.
In equity mutual funds, the fund manager takes care of the mutual fund portfolio, making it a convenient form of investment. However, while investing in direct equity requires an individual to constantly monitor their investments due to fluctuations in stock price movements. Investors in direct equity rely on their own market knowledge, while mutual fund investors rely on the fund manager’s expertise.
Investors can start investing in equity mutual funds with an amount as small as INR 500. They also have the convenience to choose the SIP option to invest regularly in a disciplined manner. On the contrary, investment in direct equity depends on the value of the share. Some shares quote high prices, which are inaccessible to small investors.
The taxation of direct equity and equity mutual funds is the same. When the holding period of the share or mutual fund is less than a year, then short term capital gains arise, which are taxable at 15%. Similarly, when the holding is more than a year, then long term capital gains arise. Long term capital gains are taxable at 10% over the sum of Rs. 1 lakh without indexation benefit. In addition, when investors invest in an ELSS fund, a type of equity mutual fund, they are eligible for deduction under Section 80C up to Rs. 1.5 lakh of the Income Tax Act, 1961.
Who Should Choose Direct Equity Investment?
Direct equity investment is suitable for investors who have experience and understanding of how the stock market works. They must stay informed on what’s going on in the country and around the world. More importantly, direct equity investors need to take tactical calls on timing and purchase or sale of shares. Thus, direct equity can be a good option if investors can meet these conditions and dedicate time.
Sometimes direct equity requires investors to stay invested for a long period to realise true growth. For instance, some stocks might give up to 100% returns or more over some time. It is essential for investors to understand that the stock market is volatile and can lead to substantial swings in the short term.. Having the right pick for investment can help you maximise growth in your investment portfolio.
Who Should Invest in an Equity Mutual Fund?
Equity mutual funds are ideal for investors who are beginning their journey for the first time in stock markets. These investors do not have the expertise to choose stocks for their investment portfolio. Thus, a professional fund manager with expertise and competence helps to bridge the gap. Additionally, equity mutual funds are suitable for investors who do not have time to conduct in-depth research. Further, with limited time and experience, equity mutual funds are an ideal option.
Equity mutual funds also have different options for investors to choose from based on their investment objective. They can regularly invest with small amounts through a SIP option. Also, with the SWP option, they can withdraw in case they need regular income. Moreover, equity mutual funds come with an ease of liquidity subject to exit load. Therefore, equity mutual funds are best suited for longer investment horizons at least 5-10 years away.
In a nutshell, direct equity investment is ideal for investors who want the flexibility to build their own portfolios. Also, they have a good understanding and knowledge of stocks to opt for direct equity investing. Experts advise that equity mutual funds can be the best choice for first-time investors as well as experienced investors since fund managers professionally manage them. Hence, there is no right or wrong when it comes to investing, and it is the selection of the right stocks or funds based on the investor’s financial objective, investment horizon and risk tolerance levels. However, both are subject to volatility, and one should read all the scheme documents carefully.