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Stocks vs mutual funds: What's better?
Personalfn.com | April 10, 2008 15:38 IST
It is common for investors to grapple with various investment options. So it's not surprising that at any point of time, their 'to do' list usually has at least half-a-dozen investment options spanning various assets.
As if investing isn't enough, they also have to make elaborate arrangements to track their investments, take revised decisions (in case investments aren't working out as expected) and re-allocate assets (in case allocations have deviated sharply from original levels).
If it looks like investing is a full-time activity, then you are right, it is. Your next question probably is -- if investing is a full-time activity, how does one balance his work (which is also full-time) with investing?
The answer to this question is simple. Between the two (work and investing), focus on doing what you are good at and give up the other option in favour of someone who is adept at handling that responsibility.
In industrial parlance, this is referred to as division of labour, where each team does what is best suited to its own skill set and temperament.
Since most investors have limited skills in managing investments/finance, it's an easy choice to make for them about what they want to continue doing and what they want to give up.
Within the domain of investments, two options that investors regularly grapple with are stocks (i.e. direct equity investing) and mutual funds.
Both have their advantages, although this note does not get in to that debate. Instead, in light of the present discussion about investing being a full-time activity, let's see how stocks and mutual funds face off against one another.
1. A matter of time
Investing directly in the stock markets is a full-time activity. It may sound like a one-time activity, but trust us, it isn't. There is research to be done pre-investment and post-investment. And research on a company does not just involve knowing its business.
The investor is expected to master several subjects, i.e. prospect of the sector, other companies operating in that sector and how the company (under review) is superior to them.
The investor is also expected to study the economic and political climate of the country to gauge the bearing they can have on the sectors and companies in them.
Having done this research before investing, the investor is expected to continue doing it even after he has invested in it so as to ensure he is invested in the right company/companies.
If you still aren't convinced about the research workload consider this -- most equity research teams have analysts studying each of these areas (economy, sector, company).
So by researching these areas all by himself, the investor is replicating the efforts of an entire team. If he has the time for it, then he can consider taking up investing as a full- time activity. Of course, he will first have to consider resigning from his present job!
On a more serious note, if you believe that you can take out time from your work to invest directly in equities, then it is advisable to invest in proportion to your free time.
The free time will prove critical in tracking the companies that you wish to invest in. For instance, if you are very busy, then ideally you must either not invest at all in equities (directly) or invest sparingly, because you don't have sufficient time to track the companies.
Moreover, if you are busy today and expect to get even busier tomorrow, then re-consider whether you should be investing directly in equities at all. No point in starting something that you will unlikely find the time to finish.
Conversely, investing via the mutual funds route is far less time consuming. Sure, it might take a while to select the right mutual funds (your financial planner should be able to help you with that); however beyond that, a better part of the responsibility lies with the fund manager and your financial planner.
2. Investing skills
If you have the time to take up investing then you have cleared the first hurdle. There are other hurdles to be cleared like investment skills. A successful fund manager hasn't got where he has, only because he has the time to invest; he has something even more scarce -- the skill and knack of investing.
And the skill sets to invest are not acquired overnight. Fund managers earn their spurs over the years after going through several market trends and cycles (ups and downs) and after making several mistakes. So apart from the time factor, investing demands a lot of skill and experience.
3. Access to research
Most investors who wish to take up investing as a full-time activity are likely to hit a roadblock in getting unrestricted access to quality research. While conventional wisdom suggests that the annual report should prove sufficient in this regard, the bad news is that the annual report is just the starting point.
For more information you have to read up extensively on sectors and companies in those sectors. While some of this information could be available for free (in libraries or on the internet for instance), the quality inputs (read updated and insightful research) are usually available for a stiff fee.
Getting reports (premium or otherwise) is not the only thing, ideally you would like to meet the company management if possible or an authority on a particular sector. Again, these meetings are elusive, usually reserved for the elite, so retail investors are unlikely to get an audience easily.
While you can meet the company management over an AGM (Annual General Meeting); meetings of reputed companies are usually well-attended and you will be lucky to get even a few questions past the huge audience.
Mutual fund managers on the other hand have no problem with these issues. For them, accessing research (regardless of the price) is never a problem. Meeting up with the company management and industry bigwigs is something they do on a regular basis.
In fact, investment decisions are rarely taken without these inputs. On the other hand, the lay investor will often be compelled to take an investment decision devoid of these inputs. It is not surprising then, that there is usually a wide chasm between the quality of investments across both these categories (fund managers and lay investors).
While it may appear that we have done everything possible to discourage investors from investing directly in equities, the harsh reality is that investing directly in stock markets is easier said than done.
It's something that catches the fancy of every lay investor, but as we have seen, it's something that is beyond most of them. The solution to this problem is that investors delegate this responsibility to a competent money manager (fund manager) who is best placed to invest their monies in the best possible manner.
The investor on his part can go about his own business, which is where his expertise and skill sets lie.
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