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5 reasons why mutual funds score over stocks
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September 27, 2005 08:22 IST

The way investors are taking to mutual fund 'new fund offers,' one would think mutual funds were going out of style. This probably leads a lot of risk-taking individuals into believing that mutual funds are a great way to invest else so many investors would not be putting their hard-earned money in them.

To be sure, mutual funds are a great way to invest in equities, but there are some reasons for the same, more fundamental than just soaring investor interest.

For retail investors, who have money, but don't have time and expertise, mutual funds are perhaps the only way to invest in stock markets. Also the mutual fund route is certainly a lot more 'surer' and less riskier than investing directly in stocks.

1. Power of knowledge

When you don't have it, outsource it -- that is a mantra a lot of corporates are chanting. There is no reason why investors should not do the same. Investing in equities requires a fair understanding of global and domestic economics, interest rates, political events, stock market among a host of other factors.

If you don't have a view on these factors, then you must find someone who has one. That's where mutual funds come in.

2. Diversification

A lot of investors take to stocks because they find them very exciting. During a rally, stocks move up a lot faster than mutual funds. They clock blistering growth and set the cash registers ringing, so to speak. Mutual funds on the other hand are steady and therefore perceived as boring.

The point investors miss out on is that mutual funds work towards risk mitigation before they work towards clocking growth. By diversifying across a number of stocks and sectors, investors lower the risk during a market downturn that usually follows a blistering market rally.

Let's understand this in light of what actually happened in the stock markets some years ago.

Mutual funds save the day
Indices ---
BSE Sensex 100.00 193.58 119.75
Diversified Equity Funds ---
Sundaram Growth (G) 100.00 246.30 153.70
Templeton India Growth (D) 100.00 225.50 164.22
HDFC [Get Quote] Equity (G) 100.00 301.18 192.47
Stocks ---
Wipro [Get Quote] 100.00 359.76 115.56
Infosys [Get Quote] 100.00 366.26 219.59
Mphasis BFL 100.00 316.45 58.13

It was 1999-early 2000. On display was one of the most scorching stock market rallies the country had ever seen until then. Technology, media and telecom were the leading lights of the new economy. Then the stock market collapsed burning a big hole in investor portfolios.

However, as is evident from the above table, mutual funds did a better job at safeguarding the investor's portfolio than stocks.

Consider the performance of the leading software stocks in that rally. While they did hit the roof at the peak of the rally, their fall from grace is just as well-documented.

At the end (in October 2000 when the market fall stemmed) the diversified equity funds in our sample were in much better shape than the BSE Sensex and the stocks except Infosys. The mutual funds did better than the stocks mainly due to prudent fund management based on the virtues of diversification.

3. Solid structure

Mutual funds have a solid 3-tier structure in place that works in the investor's interest. The promoter/sponsor sets up a mutual fund, but does not exercise direct control over it.

For this, it sets up a board of trustees. The trustees in turn set up an asset management company (AMC). The latter looks after the day-to-day administration, sales, marketing and fund management.

This way there is very little link between the sponsor/promoter and the mutual fund schemes. This ensures that mutual fund schemes are managed professionally without any 'interference'.

On the other hand, Indian companies still have some way to go before they can be managed as professionally as mutual funds. The promoter's 'involvement' is considered normal and any negative news at the promoter's level often percolates down to the stock.

4. Offering solutions

How many times have we heard this before - mutual funds are very flexible? There is a reason for that. Today mutual funds have evolved at a level that gives investors solutions for retirement planning, planning for child's education/marriage, even buying a house to outline a few goals.

There are mutual funds tailor-made to help investors achieve these financial goals.

With stocks it's a little different. Stocks do not offer solutions apart from a very broad solution of providing capital appreciation. You can't provide for retirement or for a child's education through stocks, rather you must build a customised portfolio of stocks and debt and actively manage it to help you meet a financial goal. That is exactly what mutual funds do.

5. Tax neutral

You might say that even in the mind of the finance minister, there is no difference between stocks and equity-oriented funds, at least not where tax benefits are concerned. Long-term capital gains on both stocks and equity-oriented funds are tax-free. Likewise, short-term gains on both are taxed at 10% plus surcharge and education cess.

Also dividends from both are tax-free in the hands of investors. So investors do not stand to lose out on any tax benefit by investing in equity funds vis-�-vis stocks.

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