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Direct Investment In Stocks v/s Mutual Funds This article compares mutual fund investments with direct equity investments. It gives pros and cons of each, and suggests what type of investors should invest in each. You are a savvy investor. You read a lot about personal finance and investing, and therefore you know very well that equities give the best long term, inflation beating returns among all asset classes. You need to save for some long term financial goals, and obviously, stocks are your first choice. You decide to invest in a disciplined manner to achieve your goal. So, you open a depository account, a trading account, and start investing in stocks. The question is - is this approach correct? Should one invest directly in stocks, or take the help of experts? Well, the answer would vary from person to person. So, let me compare the two methods of equity investment, to help you find your own answer! Factor 1 - Time Many small investors “invest” in stocks for the short term based on tips and rumours, and that is the most inappropriate “investment” strategy. This is trading, and this methodology can suit only traders. They are the ones who invest huge capital and trade with large positions, such that even a 5 paise increase in a stock’s price is very profitable for them. But for small investors, it is a losing battle. Investment in shares should be done only for the long term, keeping in mind the soundness of the company’s strategies and management. Investment in stocks, therefore, needs a lot of research. It involves fundamental analysis - a study of the fundamental factors that affect the performance of a company. These factors may include the industry in which the company operates, growth rate of the industry, domestic and international competition, overall economic scenario (interest rates, inflation, exchange rate, etc), and so on. This research needs to be done not just before choosing a stock, but even for its continuous tracking during the entire holding period. This kind of research needs a heavy investment of time. Do you, as a small investor, have this kind of time to spare? Factor 2 - Expertise Researching a company requires a thorough knowledge of valuation and accounting principles, and interpretation of various financial ratios like RoE, RoCE, RoNW, etc. It would also require access to latest financial results and other financial information about companies. Fundamental research would also require knowledge of the industry in which the company operates. Do you have such access and expertise? Factor 3 - Reaction Speed If there is a sudden change in economic factors, and it changes some of the fundamental factors affecting the company, would you be able to think in a dispassionate, level-headed manner? Would you be able to act fast and react? Eg: Infosys Shareholders - When markets shot up from 13000 to 21000, Infosys crashed from 2400 to 1500. Infact all IT cos have faced similar situation. But everyone stayed on. Had the same money been in Equity Funds, it would have grown substantially by now. Factor 4 - Control Over Investment How important is “control” to you? Do you want to decide how much is invested where? Or you can trust an external expert for your investments? How about investing through Mutual finds? Doesn’t it have its own loading and administrative charges and the fund managers making merry on your hard earned money? And can’t we see the best performing mutual funds and follow their portfolio? These are some of the factors that would help you in deciding whether to invest directly in the stock markets, or through mutual funds. The advantages of investing through MFs: 1. They have experienced fund managers, having a good understanding of stock markets. 2. MFs hire researchers, who have an in-depth knowledge of various industries. They also understand various valuation principles well. 3. These experts work full time on researching companies, and are therefore able to better identify good companies. 4. MF researchers often talk directly to the management of the companies, so they get a better insight into the company’s strategies. 5. MFs actively manage their portfolio. When MFs buy and sell stocks, they don’t have to pay capital gains as you do when you churn. 6. Since MFs are managed by fund managers whose full time job is to manage money, they can react to any sudden developments in a timely manner. Please also keep in mind the following disadvantages of investing in MFs: 1. Lack of control: Once you invest, you, as an investor, would not have any control of where your money is invested - it would be invested based on the MF scheme’s investment philosophy. (Note: This actually can be the primary reason for investment in an MF - since you don’t have the time and expertise, you trust the experts, and let them manage your money!) Therefore, you should choose the MF scheme carefully, such that its objective is in line with your investment objectives. If you are convinced that a particular sector is going to perform well in the future, you can invest in a MF scheme that invests specifically in that sector - you can invest in a sector fund. Such schemes come with considerable risk, as they are not diversified, but this is the maximum control you can have while making MF investments. 2. Management fee: MFs charge Entry Load and a yearly management fee. This fee is charged to cover for research and other costs that the MF scheme incurs in the course of its investments. Since this is a yearly fee, it would have an impact on your returns. But, at the same time, one can also argue that this money is used to perform better in-depth research, and therefore provides a better overall return on your investment! Now that you know the advantages and drawbacks of MF investments, you should be in a better position to decide whether you want to invest directly in stocks, or want to take the mutual fund route! Another form of investing in equity market is PMS. PMS is usually tailor-made for your needs. Based on your financial goals, portfolio managers create investment portfolio for you. For creating and maintaining your portfolio, PMS charges fees. Also if your portfolio earns profit beyond a certain amount, then the portfolio manager shares the profit. However if there are losses then the same is charged to your account only. Also it is not tax efficient as there is an on-going dispute between PMS & IT. department whether the churn in portfolio to be considered as STCG or business income & taxed at highest rate. Also smart investors who compare their PMS performance vis-à-vis MFs are not at all excited as MF performance is consistently beating all PMS returns over all time frames. Another catch is to ensure that portfolio created and maintained for you is tailor-made and that the PMS is not like another mutual fund scheme, where all investors get the same portfolio. So, do try everything. But make sure you finally decide Mutual Funds route for your wealth creation as only Mutual Funds offer maximum convenience & highest tax efficient returns with maximum liquidity. |
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