Stocks or mutual funds? It's a question that is often said to have no clear answer, but that's actually not true. Even though I myself have been guilty of saying this, probably in these very pages, it does have a clear answer. The problem actually is that it has no clear universal answer, one that applies to every single saver. The true answer is clear, but it's your personal answer and you have to figure it yourself.
Some people are best suited to be mutual fund investors while others are best suited to stocks. Still others can successfully transition from funds to stocks. Even for stock investors, it makes sense to use mutual funds for tax savings and for the fixed-income part of their investments. In any case, it's a question where the answer is not about the question as much as it is about you.
One is to choose stocks for yourself and buy and sell them yourself. And the other to invest through equity funds. The final goal is the same, to benefit from the superior returns that equity investing offers. However, in terms of what you do, the two routes are completely different.
However, the central point is unarguable: unless you are an expert investor or are able to put in the (considerable) time and effort in becoming an expert, it does not make sense to invest in equities directly. Therefore, for every beginner - without exception - the choice is quite straightforward: you must invest through mutual funds. I'm not suggesting even for a moment that an individual can't be successful in investing directly in stocks. There are many investors who invest themselves with superior results, and Value Research itself has a premium Stock Advisor service that helps people do that.
However, for a beginner, the odds are not favourable. An even bigger problem is that even those few would have probably started tasting success after many failures, and each of these failures would have landed them with some losses. For most of us whose goal is to simply get higher returns for our savings, this business of learning through losses turns out to be a dealbreaker.
Equity-based mutual funds solve all these problems quite simply. There are many advantages to investing in equity through mutual funds. A major one is disciplined diversification. Fund managers operate within an institutional framework, which enforces certain ground rules of investing. For instance, these could be a set of rules defining the investments such as there must be at least 15 or 20 stocks with no less than X per cent of the total portfolio. The stocks must be spread over at least five sectors with no sector being less than Y per cent. At least Z per cent must be held only in large companies because they tend to be more stable in bad times. Taken together, such rules define a framework which ensures that the portfolio stays diversified and safe from shocks that may strike individual stocks, sectors or types of stocks. Individuals who manage their own stock investing would rarely have the knowledge or the discipline to do all this.
Being able to start investing in small and flexible chunks is another big advantage. If you try to build a diversified portfolio with stocks by buying them directly, you'll need a relatively large sum of money - at least a few lakhs to begin with. In mutual funds, you can start off by owning the same with a few thousand rupees. You can invest regularly and automatically with a fixed amount every month, and you can actually save tax under Section 80C by investing up to Rs 1.5 lakh a year in designated equity mutual funds.
Tax efficiency is another reason. All equity portfolios need some buying or selling as individual stocks become more or less desirable. If you are trading stocks yourself, these transactions will mean a tax liability. However, in an equity mutual fund, this trading is done by the fund manager inside the fund. You don't have a tax liability because you haven't made transactions yourselves. There's a further multiplier to the tax saved because the money stays available as an investment and thus gains even more. For long-term investments that compound over years, this can make a huge difference.
Sometimes, in the media, the stocks-vs-funds question is framed as one of a comparison of return, generally by comparing average mutual fund returns with benchmarks. This is a meaningless comparison. Benchmark and average returns are just the soil - what grows in it depends on the gardener.