Here’s all about Investing in Equity Mutual Funds vs. Individual Stocks:
Whether equity mutual funds are better than individual stocks or not?
This question has been perplexing investors from quite some time. The investors want exposure to return potential of equity shares. But they are unsure as regards combination of securities and portfolio management. Additionally, the fee structure of mutual fund investments increases apprehensions as regards getting value for money.
At this juncture, it becomes important to know the exact nature of mutual fund investing vis-a-vis individual stock investing.
Diversification involves investing in a number of stocks instead of a few securities. It is done to eliminate portfolio risk. The value of a well-diversified portfolio is affected primarily by market risks. If one sector performs poorly, then other better-performing sectors may keep the portfolio value intact.
In the case of equity mutual funds, you get the benefit of diversification. By investing a nominal SIP, you get exposure to a range of securities. The fund manager does an in-depth analysis while including securities in the portfolio. He chooses securities having a low correlation to minimise the overall risk.
But, in the case of individual stock investing, you may fall prey to various kinds of portfolio risks. The unsystematic risk or firm-related risk isn’t eliminated as much as in equity mutual funds. Any news of minor or major development in the company may affect prices of its shares adversely. It could wipe out your portfolio returns overnight.
If you want to achieve a similar level of diversification, you require a relatively larger amount of funds compared to lean mutual fund SIP. Additionally, you may not possess the requisite analytical tools to gauge portfolio risk like a fund manager.
2. Risk-Return perspective
The fundamental rule of investment relates to risk-return trade-off. It says that higher risk securities have potential to give higher returns and vice-versa. In the case of a high-return high-risk investment, the security would gain more and lose more with every movement of the benchmark index.
Let’s understand this with the help of table given below.
The table shows the fluctuations in the returns of a large-cap fund vis-à-vis the stock holdings of the fund. HDFC Top 200 Fund is a large-cap equity fund whose returns have fluctuated lesser in comparison to its stock holdings.
The highest return of HDFC Fund is 23.28%, and lowest return is 4.74%. However, the maximum return of Maruti Suzuki India is 70.62%, and the lowest return of Tata Consultancy Services is -0.83%. The individual stock returns have varied over a wider range as compared to HDFC Fund; so much so that they have given higher returns as compared to Sensex, which is the benchmark index.
It’s because HDFC mutual fund is a portfolio of securities from diverse sectors. A fall in prices of one stock will be cancelled out by the rise in prices of the other. This benefit might not be available in case of individual stock investing.
Although the return generating potential is higher for individual stocks, but the probability of losing is also higher. As compared to this, equity mutual funds can generate stable returns over the given investment horizon.
Investing in equity mutual fund enables you to enjoy the high returns of stock market coupled with stability and steady wealth accumulation.
Also read: Risk vs volatility: here’s the difference
3. Cost structure
Fee and expenses levied by an investment vehicle have implications on the residual returns earned by you. Your returns get slashed by several times with every percentage increase in the cost structure. It happens due to the effect of compounding. You should aim for a vehicle that has a transparent cost structure.
Mutual fund charge a fee which includes fund management fee, agent commissions, registrar fees, and selling and promoting expenses. Put together, these fall under the purview of Expense Ratio. It is an annual recurring cost which can be found in half-yearly reports of the AMCs. It is charged as a percentage of fund’s average weekly net assets.
Suppose your fund generates a return of 10% and has an expense ratio of 1%. Your net returns get reduced to 9%.
Individual stock investing has a lesser complicated cost structure. It involves brokerage and securities transaction tax. Stock investing has become cheaper than mutual funds. Some of the discount brokers even go to the extent of waiving brokerage on delivery-based trades.
Hence, delivery-based trades are cheaper than intraday and F&O trades. You incur a cost only when you buy/sell a security. There are no recurring charges like mutual funds throughout the investment horizon.
4. Professional Management
Portfolio management is a specialised activity. It involves sophisticated functions like stock picking, stock tracking, asset allocation and rebalancing.
As an individual investor, you might be good at one but lagging at the other skill. To perform each of these functions correctly, you need to have sound financial knowledge and understanding of market movements.
Moreover, it is a time-consuming activity. You have got other things to do as well!
Individual stock investing is for those who are passionate about equity markets; those who love to read the charts and can do an in-depth fundamental analysis.
But those who don’t possess sufficient financial knowledge, equity mutual funds are the in-thing.
Here, you get the benefit of the fund manager’s expertise. All kinds of portfolio-related actions will be done by the professional fund manager. He will ensure that only the best stocks with potential for long-term returns enter the portfolio holds.
Investing in individual stocks is a precarious proposition. Even if you are well-versed with the market knowledge and portfolio management, you may end up losing a huge amount of money. You may regard individual stock investing as a double-edged sword.
It’s safe and rewarding to be a passive investor. Go for equity mutual funds. It’s convenient, and you don’t need to monitor your portfolio regularly. You are freed from the emotional stress of timing the financial markets. Moreover, equity funds coupled with goal-orientation will help in the achievement of financial goals in a fast-paced manner.