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The old dilemma: stocks or mutual funds?

For the beginner, should it be stocks or mutual funds? The logic points in one direction.

Mutual funds vs stocks: The logic points in one directionAnand Kumar

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dhanak हिंदी में भी पढ़ें read-in-hindi

I've realised recently that some people find my attitude of equal opportunities to various types of investments available to the individual a bit unusual. Instead of 'equal opportunities', I should probably say 'sabka saath, sabka vikas', but the idea is the same. In this day and age of finfluencers, a routine modus operandi to gather an audience is to be against something. Everything has some negative points, and one surefire way of gathering a crowd is to say that here, let me save you from losing all your money on X or Y type of investment - this is why they are evil, and this is why you must do Z, which I'm here to promote.

The thing to understand is that there are very few types of investments that are unmitigated disasters. Apart from a few like derivatives, non-term insurance products and fraudulent 'assets' like crypto, practically every kind of asset class has some usefulness for some investors, in some situations and in some proportion. The key is to make the right choices.

I've always advocated for putting a significant portion of your long-term investments in equities. However, the challenging part is figuring out the best approach to do this. For newcomers, it's not easy to figure out where to start. It's well-known that there are two main methods of investing in equities. One way is to select and trade stocks on your own, and the other is through investing in equity mutual funds. While the ultimate objective of both methods is to capitalise on the high returns offered by equity investments, practically everything else is different.

Unless you're already a skilled investor or willing to invest significant time and effort to become one, direct equity investment is generally not advisable. As such, for all beginners, the decision is relatively simple: invest through mutual funds. This isn't to say that individual direct investment can't be successful. Indeed, many investors manage their own investments with great results, and Value Research even offers a Stock Advisor service to help you succeed in this. Nonetheless, success requires experience and effort, and even those few who do succeed often do so after experiencing several failures, each accompanied by some financial losses. For most people, whose primary goal is to achieve higher returns on their savings simply, the prospect of learning through financial setbacks is a significant deterrent.

Investing in equities through mutual funds offers a straightforward solution to many challenges, bringing several benefits. One significant advantage is disciplined diversification. Fund managers adhere to rules that enforce diversification across the portfolio. For example, they may be required to invest in at least 20 stocks, with no single stock representing more than a certain per cent of the total portfolio value plus similar limits for sectors, business groups or company size. Together, these guidelines ensure that the portfolio remains diversified and resilient to shocks affecting individual stocks, sectors, or types of stocks. Most individual investors lack the expertise or discipline to achieve this level of diversification on their own.

Then, there's the ability to begin investing with a small amount and in flexible increments. To create a diversified portfolio through direct stock purchases, you would require a substantial initial investment, typically several lakhs rupees. In contrast, mutual funds allow you to start with just a few thousand rupees. You have the option to invest a fixed amount monthly, enabling regular and automated contributions through SIPs. A big advantage is potential tax savings by investing in tax-saving equity funds.

Talking of tax, there's yet another advantage that boosts equity mutual fund returns. All equity portfolios need some buying or selling as individual stocks become more or less desirable. If you are trading stocks yourself, then 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 the years, this can make a huge difference.

That's a persuasive list, isn't it? However, don't let me convince you to never look at stocks. Once you have the experience and can spare a bit of time, do look at equity investing. It can be very rewarding, and many smart investors use equity and mutual funds, each for its own purpose.

Also read: Stocks vs Equity funds vs Index funds


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