What follows is an interesting imaginary conversation between Kirtan A Shah and an investor about how investing in mutual funds is better than investing directly in stocks.
Investor: I want to invest in equities.
Me: How long can you stay invested? How much risk can you take? What's your returns expectations?
Investor: I can stay invested for 10 years; am okay with volatility and the return expectation is 13-15 per cent.
Me: Okay, we will invest in ABC Flexicap, XYZ Midcap and PQR Small Cap mutual fund.
Investor: Can we not invest directly in stocks?
Me: You want to generate returns so how does it matter where these returns are coming from (direct stocks or MFs)?
Also, you are not going to be able to track sector rotation, corporate actions, news, etc (if you are directly investing in stocks).
As a retail investor, a mutual fund is a much better option.
It will make you the returns you are expecting over 10 years.
Investor: But won't investing in stocks directly generate higher returns?
Me: Here's what you need to know.
1. It's a misconception that you will generate higher returns by investing directly in stocks.
2. In direct stock investing, the brokers' app does not show you the portfolio XIRR (extended internal rate of return). As a result, you don't understand your overall return. Ninety per cent of investors can't beat fixed deposit returns (from investing directly in stocks) over time.
3. One stock may do well but the overall portfolio return is always grey.
4. When you invest in a mutual fund, depending on the kind of fund you choose, your money will be invested in stocks.
You also have the advantage of deciding how much of your money is invested in stocks. For example, if you are investing Rs 100, you can decide if you want Rs 30 or Rs 50 or Rs 75 or Rs 100 invested in stocks; the rest of the money can go into other kinds of investment.
If you want to take a higher risk to generate higher returns, you can increase your allocation to mid and small cap funds and give it at least 10 years.
It is not fair, however, to compare a stock that gave 50 per cent returns to a large cap fund, which is a portfolio.
5. What you must remember is that you will not be able to find such stocks consistently without losing money other stocks you have invested in. Hence, your net returns are nowhere close to the return that your one stock gave.
PS: The right combination of mutual funds and a longish time horizon can generate 13-15 per cent CAGR, which is a decent return when it comes to investing in investing.
If you want more, you need to accept the risk and allocate higher than normal investment in mid and small cap funds so that you generate higher returns over time.
But if you think investing in direct stocks will consistently be able to make a retail investor a 30-35 per cent return, you are probably among the top 0.1 per cent.
For everyone else, there are mutual funds.
You can ask Kirtan A Shah your personal finance questions HERE.
Disclaimer: This advisory is meant for information purposes only. This advisory and the information in it does not constitute distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this QnA or an attempt to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.