Which is a better - investment in stocks or mutual funds?

The ultimate motive of every investment you make is to gain higher returns, thus it is fair to compare returns on mutual funds investment with returns on stock investment.

Jun 18, 2019 01:06 IST India Infoline News Service

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The most common question asked by people new to the stock markets is whether they should invest in stocks or mutual funds. To begin with, let us understand the difference between the two. Buying stocks gives you partial ownership of a company. Mutual funds, on the other hand invest a pool of money that is collected from various investors into stocks, bonds or both depending upon its investment objective.
 

The returns perspective Mutual Funds vs. Stocks

The ultimate motive of every investment you make is to gain higher returns, thus it is fair to compare returns on mutual fund investment with returns on stock investment. Undoubtedly, the return potential of stock investments is better depending upon its pedigree and market conditions. For instance, the stock of a blue chip (a well-established, financially sound company) such as HDFC Bank has provided returns of 25-26% over a 3, 5 and 10-year period. In comparison, a blue-chip fund has provided returns in the range of 10-17% during the same period.
 

The risk factor in investment

 
The major benefit of stock investments is higher returns as compared to mutual funds, however it should also be noted that the risk is also greater vs. investing in mutual funds. Unless you know how and when to invest (market timing) and understand the companies you are investing in and their prospects through adequate research, stock investment may prove to have disastrous consequences, especially in a period of volatility. On the contrary, mutual funds are managed by fund managers who are market experts. Further, considering constant vigilance of fund managers over the markets backed with research and analysis, they are better equipped to make investment decisions that may benefit investors even when markets are volatile.
 

Cost of investing

 
Investment in both stock and mutual funds is not free. As an individual investor, you need to have a demat account to invest in stocks. To maintain a demat account you need to pay a minimal amount. Besides you need to pay a brokerage fee and security transaction tax for stock investment. While you need not have a demat account for mutual funds, you pay for the operational charges and fund management fee through the Total Expense Ratio or TER expressed in your fund statement. In case of equity funds, the TER is capped at 2.25% of the scheme.
 

Why mutual funds may be a better investment option

The primary benefit of mutual funds in comparison to stocks is that they reduce the risk through diversification i.e. through investing in a large number of stocks. There are various kinds of mutual funds that you can choose to invest in depending upon your risk capacity, investment horizon and financial goals. Mutual funds let you invest through a systematic investment plan or SIP, where a fixed sum of money is directed towards investment each month. SIPs however, work best in the long-term when associated to a goal.
 
 By investing through the SIP route you get the benefit of rupee cost averaging. This means that you buy lesser number of units when markets are higher and more units when markets are low. Apart from averaging your cost of purchase, this mechanism also acts as an automatic protection against volatility and eliminates the need to time the market. Over time, investment in a disciplined manner through SIPs can help you achieve financial goals at various life stages.
 
Further, SIPs also provide the benefit of compounding, where the returns from your investment are re-invested into the principal. Thus, the longer you remain invested the more you stand to gain. However, SIPs work only when they are linked to long-term goals.
 
Overall, benefits of mutual funds outweigh investment in stocks, especially if you are a new entrant into the market. Unless you have time to track the markets and are equipped with adequate market knowledge, money management is best left to the experts!  

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