Equity vs equity mutual funds? A simple question with a complex answer.
07-Jun-2022 •Dhirendra Kumar
The most important question that every saver has to answer when they start investing is this: which cryptocurrency should they put all their money in? Right? Well, not really. This column is not meant for those sorts of people.
I'm trying to answer the fundamental question: equity or mutual funds? Note that in both cases, the final goal is to invest in stocks and generate wealth with the kind of returns that comes from equity. The question is actually whether one should directly invest in stocks or invest in stocks through equity mutual funds. That question comes up sooner when savers first graduate from being just depositors to actual investors and learn the power of equity returns. The important thing is that one cannot come upon the right decision by just passively absorbing what is being said or written in the media and on social media. If you go by the noise levels alone, then you will inevitably be driven towards equity. Equity investing generates far more news and excitement than any other type of asset - that is inevitable.
That doesn't mean that it's the most suitable type for you. We often say the stocks vs mutual funds question doesn't have a clear answer, but that's not true - it does have a clear answer. The problem is that it has no clear universal answer, which applies to every saver. The answer is clear, but it's your answer, and you have to figure it out yourself.
Part of it comes down to temperament. Some of us are best suited to be mutual fund investors, while others are best suited to stocks. Others can start with bank deposits, transition to mutual funds and then to stocks. In fact, and this is very important - even for stock investors, it makes sense to use mutual funds for tax savings and the fixed-income part of their investments. So it's a question where the answer is not universal.
Still, the main point is undeniable: unless you are an expert investor or can put in the time and effort to become an expert, it does not make sense to invest in equities directly. Therefore, the choice is relatively straightforward for every beginner - without exception - 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. However, many investors invest themselves with superior results, and Value Research has a 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. So for most of us, whose goal is to get higher returns for our savings simply, this business of learning through failures turns out to be a dealbreaker.
Mutual funds deliver basic requirements like diversification effortlessly. Being able to start investing in small and flexible chunks is another significant 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. You can start by owning the same with a few thousand rupees in mutual funds. You can invest regularly and automatically with a fixed amount every month. You can 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 buying or selling as individual stocks become more or less desirable. These transactions will mean a tax liability if you are trading stocks yourself. 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. This can make a massive difference for long-term investments that compound over the years.
Sometimes, in the media, the stocks-vs-funds question is framed as a return comparison, generally by comparing average mutual fund returns with benchmarks. However, this is a meaningless comparison because returns are just one small part of the picture. Either of the two asset classes could be more suitable for you, but many factors must go into the decision.