When you start as a beginner in investing, you come at a crossroads while deciding where to invest. Direct equity or mutual funds? Most individuals go with direct equity because the stock market has been glorified in shows, movies, articles, etc. to give the best and the only external source of returns. But hold on, other options will give you almost the same amount of returns. Let’s explore what direct equity and mutual funds are before we come to a conclusion of which is better.
What is direct equity?
Direct equity refers to an investment in the stock market directly. It can be either through your personally managed Demat account or your Demat account managed by a broker/dealer on your behalf; the result being money invested in shares of companies known as equity. Direct equity can be very rewarding, however, the risk of loss here is also very high. Investors who can find the right balance of risk & return are the real market mavens. But what’s the secret to balancing your risk to reward ratio?
It is not an easy task to understand equity and the supplementary terms that come along with it. An investor needs to understand the underlying business and history of the company before investing in equity. The information you need for decision-making is contained in the company’s financial reports which you will find on the website in the investor relations section.
So if you’re a pro and keep up with all market-related news, direct equity is a better option for you.
What are mutual funds?
A mutual fund is a pool of money from multiple investors who wish to save money by investing. Asset Management Companies (AMCs) invest the amount in diversified holdings professionally managed by ‘Fund Managers’ who have a great track record in investment management.
As an investor, you are the owner of the units allotted to you against your investment amount, which represents the portion of the fund that you hold. Therefore, the investor is also known as a ‘Unitholder’. The increase in the value of the investments along with other incomes earned from it is then distributed to the investors in the proportion to the number of units owned by them, after deducting applicable expenses – mostly commonly the ‘Expense Ratio’ which is a fee the AMC charges for handling your investments.
Direct equity vs mutual funds
Wealth creation seems like an exhilarating concept. However, the process may not make you feel the same since it requires adequate knowledge, time, willingness, and the ability to take risk and skills.
Time spent on research:
Stock investing is not child’s play. Some individuals take months, years, even close to a decade to get their stock-picking right. Why does this happen? Because studying a company’s balance sheet and P/L statements just scratches the surface of the investment decision at hand. There’s more to it than what meets the eye. Funds do thorough research and label their selection according to relevant objectives so you don’t have to. When we speak about direct equities, one needs to look at historical data, economic conditions, type of industry, etc. An average individual looking to invest may not be able to sacrifice their extra time finding all this. In such a scenario, mutual funds come to their rescue!
Individuals may not have the necessary skills to identify suitable stocks. Owing to the fact that not everyone can dedicate time to do research, mutual funds, therefore, offer investors the expertise of fund managers. They have years of experience managing funds, practicing under the guidance of mentors. Unless you are someone who keeps up with the market, does your research, and has a perfectly logical reason for your investment, do not consider risking your hard-earned money in direct equities.
Freedom of Choice:
Freedom is abundant when it comes to choosing the stock you’d like in your portfolio. The same cannot be said for mutual funds. The only freedom of choice an investor has is in picking the objective of investment. One can pick from aggressive, conservative, hybrid, debt, equity, thematic, and even sector-based funds to invest in.
An individual investor may go overboard on a particular stock. However, a fund manager will administer risk management guidelines in place. They are bound by limits on how much can be invested in each stock & sector. Their decision to invest in a particular stock is backed by strong research conducted by them & his/her team members.
When an individual investor transacts in stocks before completing the tenure of 1 year, he ends up paying short-term capital gains. However, the fund managers may keep transacting in them at varying intervals. If the investor remains invested for more than 1 year in an equity fund, his gains are tax-free since STT (Securities Transaction Tax) is already deducted. In direct equity, one can transact freely without being taxed in brackets. However, each transaction carries with it plenty of tax charges.
Biases are almost tough to negate when one is investing for themselves. It is tough to digest that your research and study were wrong (in case it was). Emotional biases come into being when one doesn’t want to exit at the right time thinking they will receive more returns or even when a stock has reversed to a downtrend and the investor waits thinking it’s just a small blip / correction in the path. However, fund managers only use logic keeping emotions out of the way.
In the end, all practically doesn’t matter to the investor is the gains aren’t adequate. Direct equity, as we mentioned before, provides the best and highest returns. They are very volatile. Consequently, they also come with high risk. One can expect returns anywhere between 12-15% investing in direct equities. This also means they are prone to huge losses. Mutual funds, on the other hand, carry lesser risk and provide an 8-13% return on investment. You must have heard the line “Mutual funds are subject to market risk”. This is true since their underlying investment is the direct equities!
Investments eventually boil down to three things – risk appetite, time horizon, and investment objective. One needs to decide based on these three broad factors. An aggressive investor with a short time period and an objective to buy a phone should not consider investing in equity mutual funds. They should probably consult their financial advisor and invest in direct equities that provide them the capital gains required in the said time horizon.
Tarrakki – Towards prosperity