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Stocks or mutual funds: Where should you invest?

May 22, 2015 13:01 IST
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Equity investing is still fraught with peril and is riddled with sink holes that investors need to be wary of

The Indian financial markets have been significantly profitable to investors during the last one year. The returns earned by equity as an asset class have far exceeded those of safe and risk-free products like bonds, PPF and bank FDs. Quite naturally, the dice has been heavily loaded in favour of equity as a preferred avenue of investment of late. The improved regulatory environment and corporate governance have only helped.

However, equity investing is still fraught with peril and is riddled with sink holes that investors need to be wary of. Retail investors have not forgotten the 2008-2009 period when stock markets dropped precipitously and fell to almost 50 per cent of their 2007 highs with dizzying pace. A few months of market mayhem ripped apart carefully built balance sheets and speculatively constructed investment portfolios alike.

Thus arises an important question for all equity investors: Is it good to bet on the equity route directly? Or, is it more prudent to take a safer route through mutual funds?

We give you perspectives of both options that could help answer this question.

Investing in direct equity

Direct equity investment means investing in stocks of individual companies. Here, each individual stock is a representative of a unique business. Stocks are available across a wide array of sectors, sizes, business types and in many other complex variables.

A proper evaluation of a company’s stock requires expertise in financial analysis and ability to understand the business very deeply. For this very reason, direct stock investing is most suited for those who have the skill, time and the dedication to carry out extensive evaluation of the companies in which they plan to invest. Nevertheless, it is a fact that many investors have reaped handsome benefits in direct equity investment as much due to chance as expertise.

Another important aspect related to direct equity investment is the volatility of stock prices. When an investment is made in a single stock or in a bunch of 4 to 5 stocks, the change in share prices can be quite high on a given day. It is possible that a stock may go up 20 per cent or down 15 per cent, which is quite volatile. Consequently, one needs to keep a close watch on stock prices.

Taking the MF route

Mutual Fund investment works by pooling in investments of a number of investors and investing the corpus in an array of stocks that are chosen according to the fund’s investment objective. The mutual fund company operating the fund tends to have experienced fund managers, who will be responsible for all investment related decisions of the corpus of funds. Depending on the type of mutual fund, the fund manager invests in equity and debt instruments.

Unlike common investors who invest directly in stock market, mutual fund managers have years of hands on experience in financial markets, making them more qualified to take investment related decisions on behalf of the investors. The common investor therefore does not have to worry about the day-to-day sale or purchase of shares which are handled by the fund manager.

The mutual fund document clearly lists the track record and experience of the fund manager, as well as the rating of the fund as per various rating agencies. These ratings help investors to choose the best suited mutual fund for their investment needs.

Another significant advantage of mutual funds is that since there is a large corpus of money involved, the fund manger usually allocates the investment in a diverse portfolio. Unlike individual investors where the investment can be limited to 2 or 3 companies, mutual fund investors have a diverse investment perspective. In case one sector is not giving positive returns, other sectors will make up for it, allowing the investor to attain good returns.

Mutual funds also allow investors to invest using a Systematic Investment Plan (SIP). This makes it possible for people with low liquid cash to invest in the financial markets.

So, which is the better option?

It is very easy to get your stock choices right in a rising (bull) market. But, as soon as the market falls during bearish phases, many investors tend to hide behind the averages, i.e. start going for mutual funds. However, this does not automatically make either of the two options better than the other.

Mutual fund investment is suitable for people who do not have the time or expertise to track the financial markets in real time. First-time investors with limited or no knowledge of the financial markets can make the most of mutual funds to create wealth in a relatively safe and systematic way.

Investing in financial markets directly may not be everyone’s cup of tea. Even the most experienced investors have burnt their fingers at some point in time due to errors in judgment or due to bad timing. So, for an average investor, mutual funds are certainly a better bet. Skilled or veteran investors are much better placed to invest directly in equity, but need to do so with equal caution.

Illustration: Uttam Ghosh/Rediff.com

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