Mutual funds vs stocks - which investment is better? With the growing popularity of shares and mutual funds, this question has become quite common. Both options have unique features, benefits and drawbacks. You should choose the investment option that will help you achieve your individual investment goals.
What are shares?
Shares or stocks represent ownership in a publicly traded company. A shareholder gets a portion of the company's profits and a say in its decision-making through voting rights. When you buy shares in a company, you essentially become a shareholder and are entitled to a portion of the company's profits and assets. The price of shares is determined by supply and demand in the market. You can buy and sell shares on a stock exchange or through the over-the-counter market.
What are Mutual Funds?
Mutual funds are a type of investment vehicle that pools money from many investors to invest in stocks, fixed income instruments and commodities like gold. The fund is managed by professional fund managers who make investment decisions on behalf of the fund's investors. Mutual funds diversify investments across a range of securities to minimise risk, and the pricing is determined by the Net Asset Value (NAV) of the fund's underlying securities.
Mutual funds vs Shares
Before you decide which investment option is the best for you, understand the major differences between mutual funds and stocks.
| Mutual Funds | Shares | |
|---|---|---|
| Meaning | A mutual fund collects funds from multiple investors and invests the pool of money in a portfolio of securities. | A share is a unit of ownership of a company. The capital of the company is divided into shares that you can buy or sell. |
| Ownership | When you invest in a mutual fund, you buy units in the fund. You get partial ownership of the investment portfolio of the fund. | Through shares, you get partial ownership of the company that issued the shares. |
| Management | The investment portfolio of a mutual fund is managed by professional fund managers. | You have to manage your stock portfolio when you invest directly in shares. |
| Diversification | Through a mutual fund, your investments is spread across variety of stocks and sectors. | When you purchase shares of a company, you are invested in that company only. |
| Control of investment | The investment portfolio is managed by the fund managers. You do not have control over the assets in your portfolio. | If you invest in shares yourself, you have complete control over your investment portfolio. |
| Risk | Mutual funds pose relatively lower risk than direct stock investing due to diversification. | Shares have a higher level of risk compared to mutual funds. |
The debate of the stock market vs mutual funds is never-ending. You should know the pros and cons of both these options before choosing the right one for you.
Pros and cons of investing in mutual funds
Pros
- Professional management: Mutual funds are managed by professional fund managers. You benefit from their expertise and experience.
- Risk reduction: Mutual funds invest your money into a diversified investment portfolio of shares, bonds and securities. Owing to professional management and diversification, mutual funds have low investment risk.
- Taxation: Certain mutual fund categories like ELSS can provide tax deduction of up to Rs 1.5 lakh a year as per section 80C of Income Tax Act.
Cons
- Lack of control: You do not have control over the assets in the portfolio of the mutual fund.
- Costs: When you invest in mutual funds, you have to incur costs like expense ratios, exit loads, etc.
Pros and cons of investing in stocks
Pros
- Higher returns: Investing in stocks presents a greater potential for higher returns when a company’s business performs well.
- Voting rights: When you invest in shares of a company, you get the right to vote in the company's decision-making process.
- Dividend: Certain stocks distribute dividends, offering additional income and potentially offsetting losses from declining share prices.
Cons
- Volatile market: The stock market is extremely dynamic. Share prices fluctuate greatly in just a single day.
- Market knowledge: To earn good returns from stocks, you need to have in-depth knowledge of the stock market. You also need to put effort into tracking the financial performance of your investments.
- Brokerage: Every time you buy or sell shares, you have to pay brokerage to the share broker. This reduces the returns that you get from the market.
Stocks vs Mutual Funds: Which is better?
The decision between investing in mutual funds versus stocks depends on several factors, including an individual's investment goals, risk tolerance and financial situation.
Situation 1: When mutual funds are better?
- For novice investors with limited knowledge of the stock market, mutual funds can be a better option. The professional management offered by mutual funds can help inexperienced investors to diversify their portfolios and potentially enhance returns.
- For investors with low risk tolerance and those looking for more stability, mutual funds (via SIP/STP mode) are a naturally better option. The diversification offered by mutual funds can help to reduce risk. Moreover, the option to invest through Systematic Investment Plans (SIPs) can provide a more stable investment strategy.
You can use Axis Bank’s SIP calculator to estimate the amount of money you will need to invest each month to reach your desired investment goals. The calculator takes into account factors such as investment amount, expected returns and investment period.
Situation 2: When shares are better?
- For experienced investors with a good understanding of the stock market and those comfortable with higher risk, investing directly in shares may be a better option. The ability to choose specific stocks and have more control over investment decisions can lead to higher returns if the individual has the expertise to make informed investment decisions.
- For investors with a long-term investment horizon, stocks may also be a better option. Stocks have the potential to offer higher returns over the long term, particularly if the underlying companies perform well. Additionally, investing directly in shares eliminates the management fees associated with mutual funds, which can reduce returns for investors.
The amount you should allocate to mutual funds as part of your overall investment portfolio depends on your financial goals and risk appetite. As a general rule of thumb, it is recommended to have a diversified portfolio that includes a mix of stocks, bonds and other assets. mutual funds can be a valuable component of this diversified portfolio, but it is important to consider specific funds and their investment strategies before making any investment decisions.
Also Read: Mutual Funds and ETFs: Know the difference
Conclusion
There is no one right choice when it comes to investment. Your investment portfolio should be based on your financial knowledge, expected returns and risk appetite. If you have a good understanding of the stock market and are ready to assume a higher risk, you can invest in shares. But if you have a low-risk appetite, you should consider putting your money in mutual funds. If you want to build a diversified portfolio, you can invest partially in both mutual funds and shares.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.
