Imagine your friends are coming over for dinner. You decide to serve them fruit salad for dessert. You have two options:
- You can go to the market and buy fruits to make the salad yourself or,
- You can order a readymade fruit salad
Which option will you prefer?
In the first option, you have to put real effort into selecting quality fruits and spend time preparing the dessert. However, the second option allows you to choose from a wide variety of fruit salads without much hard work.
This exact dilemma is faced by investors while deciding between stocks vs mutual funds. Both stocks and mutual funds are two of the most preferred investment options today. But the question is which is more profitable between stocks vs mutual funds?
In this article, we will look at various pros and cons of investing in mutual funds vs stocks.
Let’s begin!
Basics of Stocks and Mutual Funds
Let us start with the basics and understand stocks and mutual funds.
When you buy shares of a company, you become a proportionate owner of the company. This is a direct way of participating in the stock market. Here you can earn returns mainly from capital appreciation, dividends and bonuses. Stocks can be divided into following category as per market capitalisation:
On the other hand, mutual funds are a way to indirectly invest in the stock markets.
Watch this video to understand What are Stocks
Mutual funds pool money from different investors with common investment objectives. The pooled money is invested in various instruments. A dedicated fund manager looks after the fund on behalf of its unitholders. Mutual funds are divided into three broad categories:
Watch this video to understand What are Mutual Funds
Stocks vs Mutual Funds – Which one should you pick?
Diversification of Stocks vs mutual funds
You must have heard the famous quote – ‘Don’t put all your eggs in one basket. If the basket falls you will be left with nothing in hand!’
Diversification helps in reducing risk and increases your overall returns. When you invest in just one stock, you are opting for 0% diversification and your portfolio is exposed to high volatility. If your decision proves to be wrong, you might lose your entire capital. There is no room for error when investing in stocks.
However, your fund manager splits and invests the pooled corpus in 50 – 100 different stocks. So even if 5-10 of these stocks underperform or outperformance of the remaining stocks will stabilise your overall returns.
Affordability of Stocks vs Mutual Funds
Mutual funds are far more affordable than stocks.
How?
Let’s say you want to diversify your investment and hence you decide to buy one share of every nifty 50 company. As of today, you will need a total corpus of around Rs 1,30,000 to buy one share of each component of nifty 50.
Or else you can choose to invest in an Index fund. These funds track a particular benchmark index like Nifty 50 or BSE Sensex and invests in it.
The benefit of mutual funds is that even by investing a small amount of just Rs 500, you get access to a large number of stocks which is an affordable investment option.
Time of Stocks vs mutual funds
Investing in stocks is a time-consuming process. You need to sit and analyse quality stocks by reading the company’s balance sheet and various other financial ratios.
Whereas in mutual funds, a fund manager is appointed by the fund house. This fund manager along with his team of research analysts study the financial statements of the company, meet the management and then take investment decisions. This saves investors time and efforts.
Cost of Stocks vs mutual funds
If you directly invest in stocks, you certainly have to pay lots of charges like brokerage, securities transaction tax (STT), and transaction charges. Lower the transaction charges, higher are your take home profits.
However, mutual funds aren’t free either as the fund house provides professional management and other facilities, they charge you with a nominal expense ratio. This fees varies from fund to fund. The lower expense ratio, higher will be your profits.
Variety of options of Stocks vs mutual funds
In the earlier example, you had multiple flavours of fruit salad to choose from as per your taste. Similarly, mutual funds provide you with a wide range of options to choose from – equity funds, debt funds, gold funds, value funds and a lot more.
You are free to choose a scheme as per your risk appetite, time horizon and investment objective. For instance, if you are a conservative investor, you can invest in debt funds. If you are an aggressive investor, then mid cap or small cap mutual funds will suit you better
Investors can choose from more than 29 different types of mutual funds. Below is a list of types of mutual fund schemes.
On the other hand, there are more than 4,500 stocks listed on the stock exchanges. Selecting few quality stocks from these listed companies is a tedious task. And most of them are not worth investing.
So, in mutual fund you get to choose a fund according to your risk appetite and time horizon.
Taxation of Stocks vs mutual funds
When you invest in stocks directly, you pay taxes whenever you exit a stock. This depends on your holding period. If you hold your investment for more than a year it is taxed as per long term capital gains. Whereas, if the holding period is less than a year, short term capital gains tax is applicable.
Investing discipline of Stocks vs mutual funds
Mutual funds help to better your cost averaging via systematic investment plans (SIPs). You have the flexibility to choose from weekly SIP or monthly SIP of as low as Rs 500. Moreover, mutual funds have a smart mechanism. It buys more units when the market falls. Hence, you get better cost averaging.
On the other hand, if you invest directly in stocks you might have to constantly track the market and wait for the right opportunity to invest.
Liquidation of Stocks vs mutual funds
Retail investors can sell individual shares anytime in the market during market hours. But, if you wish to liquidate your mutual fund units decides to sell shares, a huge amount of assets under management (AUM) is liquidated. Selling huge quantity also affects the share price. Hence, funds with huge AUMs find it difficult to modify or switch the portfolios.
Redemptions of Stocks vs mutual funds
Since stocks are actively traded in the stock market, you can sell them anytime during market hours. On the other hand, Mutual Funds are redeemed as per the closing Net Asset Value (NAV) of the day. So, all mutual fund investors get the same redemption NAV.
Stocks vs mutual funds – Which Gives Better Returns?
Stocks and Mutual funds provide variable returns. Stocks can provide higher returns than mutual funds as they are concentrated. Whereas, mutual funds because of its diverse nature may provide less but safer returns compared to stocks.
Let us understand the returns generated a large cap mutual fund vs few major stocks of Nifty 50 index.
| Fund | 1 year returns | 3 year returns |
| Axis Esg Equity Fund Regular Growth | 41.00% | – |
| Motilal Oswal Focused 25 Fund – Regular Growth | 38.34% | 10.87% |
| Axis Bluechip Fund – Regular Growth | 37.83% | 14.07% |
| Uti Flexi Cap Fund-regular Plan-growth | 62.21% | 15.19% |
| Axis Long Term Equity Fund Regular Growth | 43.84% | 12.37% |
Let us now compare the returns generated by these funds with some major stocks of Nifty 50.
| Stocks | 1-year returns | 3-year returns |
| HDFC Bank Ltd. | 49.08% | 44.05% |
| Hindustan Unilever | 3.67% | 65.03% |
| Asian Paints | 48.47% | 121.51% |
| Infosys | 106.55% | 128.94% |
| ITC | 12.92% | -26.10% |
Though individual stocks have generated d higher returns than top large cap mutual funds, they have higher risk associated with them.
On the other hand, mutual funds hold a diversified portfolio. Hence, negative returns are cushioned by the other stocks that perform well.
So it is safe to say that mutual funds are a comparatively safer investment option than stocks.
Final thoughts
Peter Lynch, one of the greatest value investors, rightly said, ‘If you have the stomach for stocks, but neither the time nor the inclination to do homework then you must invest in equity mutual funds.’
But selecting the right mutual fund out of 2,500+ schemes is indeed a daunting task.
Luckily, Samco’s RankMF rates and ranks all mutual funds in India and gives the most honest answer to kaunsa mutual fund sahi hai…
RankMF has created India’s first and only technology driven proprietary research and rating platform to help investors choose & invest in right mutual funds schemes to generate better returns on their investment.
RankMF with the help of technology & research experts have made their proprietary research method which evaluates more than 20 million fundamental and market data points such as expense ratios, standard deviation, market valuations and multiples, portfolio holdings and diversification/concentration of portfolio, the cash ratio of a fund, size of the fund and many more on every day basis to rate and rank all mutual fund schemes for investors to select the right funds based on its future potential and not just past performance.
To access the best mutual funds in India, open a RankMF account today. Whether you are investing in stocks or mutual funds, we will be your guide towards successful wealth creation.
