Investing in equity mutual funds versus investing in stocks

After making an analysis of common myths about the stock market and why you should invest in equities, the next jargon you have to solve is how you can invest, directly in equity or via mutual funds i.e. investing in equity mutual funds versus investing in stocks. You can invest your money either via mutual fund or you may open a demat account and invest in direct equity. In this column, we will analyse which is the better option for you between direct equity and mutual fund i.e. Investing in mutual funds vs. direct equities because at the end of the day both invest in the stocks or equities.

Investing in equity mutual funds versus investing in stocks

Knowledge required

In the case of direct equity investment, an investor needs to gather sufficient knowledge about the stock market and the stocks or shares he wants to buy. Many investors invest in direct equity without doing proper fundamental analysis, technical analysis, qualitative analysis, balance sheet, profit and loss account etc. and wait only for one year or two years to get satisfactory returns. Then, in most of the cases, these investors make a loss because of their lack of knowledge and proper analysis.

On the other hand, what intelligent investors do is that they check the fundamentals, technical, qualitative factors of stocks they want to invest and then invest. If you intend to invest via direct equity, you need to read a lot about the stock or company. Always you need to keep a close eye on the stock’s quarterly as well as annual results. You should make an investment strategy in accordance with your risk appetite and goal tenure.

In the case of Mutual Fund

If you invest via mutual funds, you neither need to read anything about a company nor need you to keep an eye on that company and its movement. The only thing you are to do is that just go to any Mutual fund company or a Mutual fund agent. Then the company or the agent will do all the things on behalf of you. You can start investment either via Systematic Investment Plan or lump sum investment. Then, the respective fund manager will invest your money in around 25-30 companies to diversify the risk. Thus, you can lessen the risk factor and generate better returns in the long term.

If you have long-term horizon you may invest in small-cap or mid-cap mutual funds which yield better returns over large-cap mutual funds. You do not need to have a cautious eye on quarterly or annual results of the respective companies. You can pick midcap and small-cap stocks after proper analysis of a stock’s fundamental i.e. debt ratio, compounded sales growth, profit growth, P/E, Balance sheet and Profit & Loss account. Whatever, if you are unable to do anything, the fund manager will manage your investment accordingly.

Systematic Investment Plan vs. Direct equity SIP

You can invest in mutual fund either by lump sum amount or on a monthly or quarterly or annual basis. In other words, you can put a lump sum or a little amount every month to invest in the stock market. Many brokerage firms such as HDFC Securities, ICICI Securities, SBICAP Securities also allow a de-mat account holder to invest like SIP via Equity SIP. Let’s make it clear with an example.

Suppose, the price of Titan company in the month of January 2019 is Rs. 1000/-. You decide to start Equity SIP of Rs. 2400/- till the next year i.e., January 2020.

Your broker will allot you 2 shares because the share price of Titan is Rs. 1000/-. So your broker will deduct only 2000/- along with his brokerage.

But if the share price of Titan company is Rs. 1500/- then your broker allots you one share because Rs. 1500* 2 = Rs. 3000/- which is higher than your set limit of Rs. 2400/-. So your broker will deduct only 1500/- along with his brokerage.

80C benefit

Equity Linked Saving Scheme (ELSS) is a kind of mutual fund offered by several Mutual Fund houses. In this scheme, your money is invested in several companies just like a normal mutual fund scheme. It allows investors to save taxes up to Rs 1.5 lakh under Section 80C of the income tax act, 1961.

Diversification

Diversification means that you have invested your money into many sectors and you are not dependent upon the performance of any one specific sector.  You can invest your money into many sectors in accordance with the market capitalization of different sectors such as Banking, Information Technology, Finance, Pharmaceuticals and health, Auto, Petroleum, Power, and Engineering etc. While making an analysis of sectors, you need to analyse the factors like the business model, financial health of the sector i.e., the debt burden on the sectors, future opportunities. After making the analysis of sectors you need to analyse the companies operating in the industry and choose two stocks of each sector for diversification. While the selection of stocks, you may consider the following factors.

  • Market capitalization
  • Debt ratio
  • Compounded sales growth
  • Compounded profit growth
  • Return on equity
  • Good dividend yield
  • Price to earnings ratio
  • Balance sheet
  • Profit and loss account
  • Free cash flow statement
Emotional bias

Many experts and analysts suggest that an individual should go with mutual funds. But if you have proper knowledge about the stock market, you may prefer direct equity. Both direct equity and mutual fund yield good returns in the long run. It is a misconception that direct equity is quite a risky job to accomplish. But in reality, it is as simple as the Mutual fund. All you need to do is the proper analysis of the companies you have invested i.e., check out quarterly results as well as annual results. If you have a long-term horizon then you need not worry about short-term volatility or market correction. At the time of market correction, you should invest more, as shares are available at an attractive valuation.

You have to be careful to choose stocks. You should buy such stocks which have strong fundamentals, balance sheet, business model, profit &loss account. There are many companies like Titan Company, Asian Paints, Pidilite Industries which have generated more than 400% return during the past 10 years. This kind of performance cannot be expected from mutual funds.

Active vs. Passive Involvement

As we have mentioned earlier that in order to make a profit in the stock market via direct equity you need to analyse the fundamentals, business analysis, balance sheet, profit and loss account, free cash flow while choosing the stock in which you are going to invest. But in the case of mutual fund investment, you need not analyse the above-mentioned points. Mutual funds are managed by fund managers who are active in this field for a long time and possess vast knowledge and experience. The fund managers pick stocks or shares in which your money is to be invested. If you give the fund Rs. 100/- then the mutual fund invests your money in different sectors like Banking, FMCG, Infrastructure, Automobiles, IT Sector etc. You may invest lump sum amount at once or you may opt for monthly, quarterly or yearly basis via SIP.

Choosing the best mutual fund or the best stocks for consistent return is quite difficult jargon to solve. But once you have chosen the best one either it is stock or mutual fund, you should continue the investment for a long time. You can choose a systematic investment plan in the case of mutual fund investment and equity sip in the case of direct equity investment. You have to be careful while the selection of stocks. As a smart investor, you should buy that stock which has strong fundamentals, robust earning number. There are many companies namely Titan Company, Asian Paints, Pidilite Industries which have delivered a return of more than 400% during the past 10 years.

No control on Stocks Chosen

After investment in mutual funds, you have no role or control in which stocks your money is to be invested. The fund manager and his research team decide where the money is to be invested. In fact, mutual fund is beneficial only for those investors who have no knowledge of the stock market. If you have proper knowledge then you are free to make a decision on yourself. You can invest your portfolio in accordance with your needs. You may invest your money in dividend-paying stocks to create a second source of income as well as growth stocks which yield better returns in the long run.

Volatility

Usually, mutual funds invest your money into 25-30 different stocks across various sectors. So, your money is distributed among various sectors i.e., the fund is diversified to lessen your risk of losing money. Now, as your risk is divided so as your returns. If one sector under performs and another sector outperforms, you will get average returns. It is a proven fact that all the sectors cannot outperform or under perform at the same time. In this way, the mutual fund is a better option. But if you do not diversify your equity portfolio and put your money into two or three sectors and if these sectors under perform, it can be disastrous for you. In this sense, if you go with direct equity, you get more vulnerable. So, you need to invest your money into at least 10 sectors and 20 stocks diversify your risk.

Return

In the case of investment via direct equity, you have to be careful to choose stocks. You should be steer clear of analysts’ recommendation, friends’ recommendations, and TV business news channels’ recommendations. Just try not to be guided by any source. You may make study and then take decisions. You should buy stocks after making a proper analysis of company’s or stock’s fundamental, technical, qualitative factors, balance sheet, profit and loss account, free cash flow etc.   There are many companies like Titan Company, HDFC Bank, Tata Global Beverages, Sterlite Technologies which have delivered a better return and are quite capable of giving you better returns over a long-term horizon.

Stock 1-year return 3-year return 5-year return 10-year return
Asian Paints 18.40% 58.99% 164.68% 1400%
Pidilite Industries 37.99% 109.86% 288.58% 2466.15%
Minda Industries -17.60% 472.90% 2257.61% 3688.37%
Titan Company 14.90% 152.43% 311.31% 2009.38%
Finally,

The bottom line is that if you have zero knowledge about the stock market and unaware of the balance sheet, profit and loss account, and free cash flow then direct equity is a difficult task to solve. You should invest your hard earned money via a mutual fund. If you have proper knowledge but have not got enough time to analyse the balance sheet, profit and loss account etc. then you should go with the mutual funds. But if you have enough time to analyse the above-said points, you may invest via direct equity. In the end, if you invest in equity with proper analysis then the direct equity will deliver multibagger return of 200-300% within 5 years where return like that level from a mutual fund is a far cry.

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