When we talk about investment in the stock market, the majority of investors relate it to equity alone. But there are many options for the investor to invest in stock markets. Among the most favored or rather popular ones for quite some time have been mutual funds. Mutual funds are further of many variants like equity mutual funds, debt mutual funds, and hybrid mutual funds. But for an average investor, it is often difficult to decide which is a better investment among stocks and mutual funds. While making an investment, investors have to look at many options and select the one based on their needs, investment goals, budget, returns, expenses or risks associated with the investment, etc.
Given below are the meaning and differences between stocks and equity mutual funds that will help the investors make better investment decisions.
Understanding Stocks and Equity Mutual Funds
When a company requires for business purposes, it has the option to issue shares or stocks for the general public to subscribe. These shares or stocks represent the ownership of the company. There are a few types of shares that can be issued by a company to raise capital. These can be convertible shares, preferential shares, ordinary shares, etc. Depending on the nature of the stock, the investor can get voting rights or preference in receiving dividends, etc.
Equity mutual funds, on the other hand, are a type of investment product that is formed by picking individual stocks or shares of companies that are listed in the stock exchange. These funds invest principally in equity and are actively managed funds. The aim of these funds is to maximize the returns on the investor’s portfolio. The fund managers use their expertise of market research and analysis to ensure better returns for the investors at relatively lower expenses.
Pros and Cons of Investing in Stocks
To make an effective investment decision, understanding the pros and cons of the type of investment is crucial. Therefore, discussed here are a few benefits and limitations of investing in stocks for a better understanding of investment in stocks.
Some of the key advantages of investing in stocks include,
- Potential for higher returns as compared to any other investment option
- Investing in stocks also provides part ownership of the company. Such ownership may or may not provide voting rights depending on the type of stocks purchased.
- Investing in stocks of different companies across various sectors allows investors to spread their risk.
- Stocks are highly liquid investments (especially stocks of listed companies) that ensure that investors can liquidate their holdings at any point.
Some of the key limitations of investing in stocks include,
- The risk of investing in stocks is quite high as compared to other investment options available in the market like ETFs, Index funds, mutual funds, debt instruments, dynamic gold investment options, etc. Furthermore, investors have the risk of losing their capital investment due to extreme stock market volatility.
- Successful stock investing requires understanding the basics of the stock market, analyzing financial statements, and staying updated with company news which can be quite cumbersome for an average investor.
- Emotional decision-making may lead to buying or selling stocks based on short-term market fluctuations, which can impact your returns negatively.
Pros and Cons of Investing in Equity Mutual Funds
After looking at the pros and cons of investing in stocks, let us now consider the pros and cons of investing in equity mutual funds hereunder.
A few key advantages of investing in equity mutual funds include
- Equity mutual funds are professionally managed by expert fund managers who have years of experience in the stock market which ensures optimum analysis of the market, stock selections, and portfolio management. This saves the investors the time and effort required for individual stock selection and creating their portfolio.
- Equity mutual funds also provide diversification by investing in stocks from different sectors thereby allowing the inherently spreading of risks.
- Equity mutual funds are generally open-ended funds that provide the option to enter and exit the fund at any point subject to exit loads.
- Investors have the option to invest in equity mutual funds through either the flexible mode of SIPs or through the lumpsum investment mode. This makes it more accessible for all categories of investors especially small investors with limited investment corpus.
A few key limitations of investment in equity mutual funds include,
- The risk of investment is quite high in equity mutual funds are they are highly volatile and can be affected by market fluctuations.
- Investors are required to pay fees for investment in mutual funds which is the highest in the case of equity mutual funds. These fees have a direct impact on the returns from these funds and therefore a high expense ratio can be detrimental to the interest of the investors.
- Investing in equity mutual funds implies that investors do not have any control over the individual stocks or the sectors in which the fund invests.
- There is no guarantee of the returns from investment in equity mutual funds and the past performance of the fund is not indicative or assurance of future returns from the fund.
Considerations for stocks investments and equity mutual funds investments
Returns on investment in stocks or equity mutual funds both are based on returns of the underlying stock. Hence, some may even say that it is essentially betting the individual investor against the professional fund managers. However, there are many points of consideration that influence the decision of an investor to invest in stocks or equity mutual funds. Some of the basic considerations and differences between the two investment products that can factor into the decision-making process are mentioned below.
Assessing Risk and Return Potential
Investing in individual stocks carries higher risk as it depends on the performance of specific companies, which can lead to significant declines in investment value if the company performs poorly. However, stocks have the potential for higher returns, especially when investing in companies with strong growth prospects. On the other hand, equity mutual funds offer a balanced approach by diversifying investments across a portfolio of stocks, mitigating the risk associated with individual stocks. While mutual funds are still exposed to market fluctuations, they aim to provide more stable long-term returns that reflect the overall performance of the stock market.
Analysing Costs and Expenses
The cost of investment is a crucial factor when deciding on an investment product. Investment in quality stocks involves higher cost while investment in equity mutual funds is at a relatively lower cost. Investors can also invest in equity mutual funds through SIPs at their convenience and gain higher returns.
Portfolio Diversification Strategies
Investment in equity mutual funds can provide investors with instant diversification of portfolios as each unit of the fund represents multiple stocks or securities. On the other hand, diversification in the portfolio of stocks can be achieved by investing in different stocks individually after careful market research and analysis.
Long-term vs short-term goals
Equity mutual funds usually need at least 5 years to 7 years to grow and provide good returns to the investors. Stocks, on the other hand, can be traded immediately if the market is on a high and can also provide immediate returns to investors.
Expert Advice and Recommendations
The biggest advantage of investing in equity mutual funds is the expertise provided by fund managers to maximize the returns on the portfolio. On the other hand, the investor has to carefully study the market as well as the financials and historical performance of the company in detail to make sound investment decisions.
Taxation is one aspect that cannot be avoided in either stocks or equity mutual funds. Both types of investments are subject to capital gains. Equity mutual funds, however, provide the benefit of a tax saving instrument in the form of Equity Linked Savings Schemes (ELSS). Equity-linked savings scheme (ELSS) is the only kind of mutual funds eligible for tax deductions under the provisions of Section 80C of the Income Tax Act, 1961. You can claim a tax rebate of up to Rs 1,50,000 and save up to Rs 46,800 a year in taxes by investing in ELSS mutual funds. These tax-saving instruments help you to save tax at the same time make substantial investments for the long term. Stocks do not have such tax-saving options. Tax is levied on the sale of stocks depending on the holding period of such stocks.
Control of investment
Investment in stocks provides investors with complete control of their portfolios. The decision to buy or sell any stock in the investor’s portfolio is solely of the investor. This control is not available to investors while investing in equity mutual funds. The fund is managed by expert fund managers that decide to buy or sell stocks or securities based on market fluctuations.
Investment in stocks or equity mutual funds both have their set of pros and cons but for new investors or risk-averse investors, equity mutual funds seem to be a relatively better option. They provide investors with the benefit of hassle-free investment and also the possibility of higher returns at relatively low costs. If you are an investor having sufficient time and relative expertise in equity analysis and also have the capacity to digest the volatility of the markets, stocks can be a good option for investment.
Equity mutual funds are considered to be safer than investing in stocks as the former offers a diversified investment option and professional management.
No. The concept of buying a fraction of shares is not allowed in India.
The target investors for investing in stocks are investors who have a high understanding of the market and a higher risk appetite. On the other hand, equity mutual funds are suitable for investors who prefer a diversified investment option and are looking for more stable returns from equity investments.
Blue-chip mutual funds are equity mutual funds that invest largely in large-cap companies which are the top 100 companies in terms of market capitalization on the stock exchanges.