Mutual Funds

Difference Between Mutual Funds vs Stocks

Mutual Funds vs Shares

The market has generated 3.5% percent in 2019 (YTD as on August 30, 2019) and -3.5% in fiscal 2020 (as on August 30, 2019), 17.3% in fiscal 2019 and 11.3% in fiscal 2018. This shows tremendous volatility.

Does this scare you?

For the majority of the people, the answer would be yes.

This is because they must be having exposure to equities directly and would be wondering what to do precisely.

This brings to another topic of interest for individuals – selecting between stocks and equities. The critical task and the process of zeroing down on an answer are dependent on your risk appetite and risk-return trade off. In this blog, we seek to discuss how to choose between stocks and mutual funds and the factors an investor should keep in mind while arriving at a decision. Let us know about mutual funds vs shares.

What is the difference between stocks and mutual funds?

While buying a stock, an individual seeks to purchase ownership in the company. To know the difference between stocks and mutual funds is the process, an individual makes money in two manners – one is capital gain, and the other is the dividend paid by the company to the shareholders. However, capital gain is realized when you sell the stock.

On the other hand, when you buy a mutual fund, you get a share in the fund. The fund pools some securities such as stocks, bonds, money market instruments, and the likes. The price of each unit in the fund is determined using the total value of all the securities divided by the number of units in the fund. In mutual funds, an individual makes money in two manners – one is capital gain, and the other is the dividend paid by the fund to the unit holders. However, the capital gain is realized when you sell the units.

Risk-Return Trade off

Stocks are riskier than funds. This is because a mutual fund is a pool of stocks and bonds. This reduces the risk of concentration in any one stock/bond. In a mutual fund, if one stock doesn’t perform, the other stocks/bonds may compensate for the under performance of others. Thus, diversification results in spreading of the risk to multiple instruments and failure of one or few don’t impact the fund very significantly.

Time to understand the basics behind fund and stocks

Another factor that differentiates a mutual fund and stock is the time taken for research. To learn investing in stocks, an individual is required to know how to read financial statements, build a financial model applicable to the sector, and conduct the valuation. On the other hand, there is no such requirement in case of a fund as the job is well-taken care of by the fund manager.

In a mutual fund, an investor is required to understand the performance metrics of the fund, risk metrics and also assess the investment philosophy, objective and track record of the fund manager.

Factors defining investment

Whether you invest in a mutual fund or stock, all your investment is decided by three factors.

  1. Decide on the risk tolerance level (remember risk and returns are positively related. For high yields, the risk increases)
  2. Time for conducting research and due diligence
  3. Expenses you are willing to give for advisory and execution

Can you lose money in stocks? If yes, how much?

Theoretically or practically, your money can reduce to zero irrespective of how strong your stock is. For example, if you had invested in the likes of Jet Airways (one of the full service providers in airline industry), Sintex (largest water tank manufacturer), and Kodak (one of the pioneers of the photography industry) the money would have nearly become zero despite the companies being fundamentally sound.

Price chart of Jet Airways
Price chart of Jet Airways
Source: Investing.com

While you may argue stating that these stocks are volatile in nature and thus the fall happens, you may also argue saying that Blue chips don’t tend to witness such movement.

But the fact is, it isn’t so.

Even Blue chip such as Vodafone Idea Ltd (formerly known as Idea Cellular Ltd of Aditya Birla Group) is one stock that has seen the steepest fall in the past five years (refer the chart below).

Price chart of Vodafone Idea Ltd
Price chart of Vodafone Idea Ltd
Source: Investing.com

So, the moral is that if you invest all your money in one or two names, you have the risk of losing your capital if the names are not well researched or if you do not track the development regularly.

Please, note we do not tend to mention that stocks are not good because there have been cases where you have multiplied your money manifold in one or two years as well. But scouting for such names is not that easy as it seems.

Now, you must be wondering what the solution to this is. We believe selecting a mutual fund makes more sense for retail investors who are not very well versed with research and do not have time to track the market.

Why should you choose mutual funds over stocks?

By now, it is clear on why should we studies mutual funds vs stocks which is better? To make the point more precise, the following are the reasons that will help you take decision rationally.

Professional Management of Money

Mutual funds leverage the knowledge and expertise of professionals to earn good returns. This is one of the primary reasons you should invest in mutual funds. Investing in the capital market without the right knowledge and understanding could be disastrous. Thus, it is advisable to invest in stocks through mutual funds if you do not have time and expertise to the work yourself.

Diversification

We already saw how investing in stocks (single names) could lead to mounting losses. These losses, at times, could result in complete loss of invested capital. Thus, investing in more than one name is essential so that your risk of concentration is minimized. Also, mutual funds invest in more than one asset class such as equities, debt, money market, and the likes that bear a different level of risk and return. Thus, at the portfolio level, the risk can be lowered against what is seen in one or a few stocks.

Convenience

Buying and selling stocks need time, as there are numerous formalities to be completed before you become the rightful and legal owner of the shares. Besides, the shares can be bought and sold only during a specified period and are not accessible throughout the day.

At this juncture, mutual funds make more sense because the legal requirements and formalities are taken care by the asset management companies (fund houses) and also the funds can be bought and sold throughout the day using technology-backed platforms such as Tarrakki.

Tax-Saving Benefits

Income generated by buying and selling of stocks also brings in income tax liability. For example, you are taxed at 15% for the gains made over short-term and at 10% for the gains made over the long-term (if the benefit is more than Rs 1 Lakh in the fiscal).

Investing in equities directly does not help in saving tax. However, there are specific mutual fund schemes that provide you tax benefits up to Rs 1.5 Lakhs every fiscal. These are known as Equity Linked Savings Schemes (ELSS). ELSS is a type of equity fund that invests in stocks and provides tax benefits under section 80C of the Income Tax Act. These funds come with a lock-in period of three years.

Also Check: Mutual Funds for Child Education

Conclusion

Mutual funds operate subject to regulatory guidelines issued by the Securities and Exchange Board of India (SEBI). SEBI has imposed certain restrictions that regulate the operations of the funds as retail participants are higher in case of mutual funds and safeguarding the interest of retail investors has remained a priority for the regulator.

To sum up, we can say that while there is potential to generate massive returns in the case of equities but they come with a significant amount of risk. On the contrary, while mutual funds generate lower returns than standalone equities but at the same time, the risk is minimized due to diversification, well-qualified team, etc. These features result in better risk-adjusted returns, thereby making them a perfect choice for naive investors or retail investors with no background of financial understanding and due diligence.

Also Read: How to Achieve Your Financial Independence with SIP?

Lastly, mutual funds come with shielded cover in terms of the regulator and provide transparent, round the clock, and efficient investment opportunity. This is what, we believe, an investor needs while accumulating wealth to meet his/her objective. So, what are you waiting for? Sign up an account today with Tarrakki for free and start your investing journey kyunki –

Mutual Funds Sahi Hai aur Mutual Funds matlab Tarrakki.

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