Can mutual funds deliver multibagger returns like stocks?

Posted On: 20 February 2025

Investors seeking to make large gains on the stock market are often on the lookout for multibagger stocks. These are investments that have the potential to multiply the original capital many times over. This may prompt an investor to wonder whether they can access multibagger stocks through diversified avenues such as mutual funds too. Read on to understand whether mutual funds can be as effective as stocks in bringing the potential for such significant returns.

Table of contents

What are multibagger stocks?
Can mutual funds give you multibagger returns?
How do mutual funds reduce risk more than stocks?
Why are mutual funds considered relatively stable compared to stocks?
Role of compounding in mutual funds
Things investors should avoid when investing in mutual funds

What are multibagger stocks?

Multibagger stocks are stocks in which the investment experiences significant increases, often multiplying their initial value several times over. Most of the multibagger stocks are of highly valued companies or under-valued ones that experience significant growth during a turnaround phase.

Can mutual funds give you multibagger returns?

While mutual funds are not typically associated with multibagger returns, they can still deliver significant growth over time. There is no such thing as a multibagger mutual fund, but funds focused on high-growth sectors or emerging markets can achieve substantial returns. Moreover, fund managers may seek to invest in companies that offer the potential to deliver significant returns in the long term, which may turn out to be multibaggers. The key difference is that mutual funds achieve growth through diversification, spreading investments across multiple assets rather than relying on a single stock. Moreover, mutual fund investments focus on building wealth in the long term while mitigating risk. Someone who actively trades on the stock market, in comparison, may seek quick gains and high returns but would be comfortable with the risk of significant loss.

Key takeaways

Multibagger stocks can deliver high returns but carry significant risk.
Mutual funds offer diversification, reducing risk compared to individual stocks.
Compounding plays a crucial role in mutual fund returns.
Mutual funds are considered more relatively stable than individual stocks.

How do mutual funds reduce risk more than stocks?

Mutual funds reduce risk by pooling money from multiple investors and investing it in a diversified portfolio. This approach reduces the impact of a single underperforming stock. For example, if one stock in a mutual fund performs poorly, the others may offset the loss. In contrast, investing in multibagger stocks can be risky, as the success of the investment depends entirely on the performance of a single company. The below table highlights how mutual funds and individual stocks differ.

Aspect	Mutual funds	Individual stocks
Volatility	Generally lower due to diversified holdings, which reduce the impact of price fluctuations in any single asset.	Higher volatility as performance depends on individual company results and market conditions.
Diversification	Offers instant diversification by pooling investments across multiple stocks, bonds, or other assets, reducing overall risk.	Limited, unless an investor actively diversifies their portfolio, which requires significant effort, capital and market knowledge.
Professional management	Managed by professional fund managers who make informed decisions based on research and expertise.	Requires individual investors to analyse and manage their investments independently, increasing the risk of errors.
Concentration risk	Lower concentration risk as most mutual fund categories spread investments across various sectors and companies. Even sectoral/thematic funds seek to diversify within a particular sector or theme.	Higher concentration risk if investments are focused on a few stocks or sectors.
Historical performance stability	Potential for more relatively stable returns than stocks, owing to diversification and professional oversight.	Performance can be highly erratic, with the potential for both significant gains and losses depending on market conditions.
Risk metrics (e.g., Sharpe Ratio)	Typically offer better risk-adjusted returns due to diversification and risk mitigation measures employed by fund managers.	Risk-adjusted returns can vary widely depending on stock selection and market timing.
Liquidity	High liquidity; units can be redeemed at net asset value (NAV), subject to fund-specific conditions.	High liquidity but subject to market demand for individual stocks; prices can fluctuate significantly during trading hours.
Market knowledge requirement	Requires less active involvement as fund managers handle investment decisions, making it suitable for beginners and passive investors.	Requires extensive market knowledge, research, and active monitoring of individual companies and industries.
Expense ratios/Costs	Includes management fees (expense ratio), which may reduce net returns; some funds also have entry/exit loads.	Trading costs (brokerage fees) can add up, especially with frequent transactions; no management fees but requires time investment for research.

Why are mutual funds considered relatively stable compared to stocks?

Mutual funds are considered more stable than individual stocks due to their diversified nature. They can invest in a mix of equities, bonds, and other assets, which helps balance risk and return. Additionally, mutual funds are managed by professional fund managers who make informed portfolio decisions based on market analysis. This reduces the volatility often associated with individual stocks.

Role of compounding in mutual funds

Compounding plays a significant role in mutual fund returns. When investors reinvest their earnings, they earn returns on both their initial investment and the accumulated profits. Over time, this compounding effect can lead to substantial growth. For example, a mutual fund with an average annual return of 12% can double an investment in about six years. This makes mutual funds a powerful tool for long-term wealth creation.

Things investors should avoid when investing in mutual funds

Chasing past performance: Past performance may or may not be sustained in the future.
Ignoring fees: High expense ratios can eat into returns over time.
Lack of diversification: Investing in only one type of fund increases risk.
Frequent switching: Moving in and out of funds frequently can reduce returns.
Ignoring risk tolerance: Choose funds that align with your risk appetite.

Conclusion

While multibagger stocks can deliver significant returns over time, they come with extremely high risk. Mutual funds, on the other hand, offer a more balanced approach to investing, reducing risk through diversification and leveraging the power of compounding. Moreover, they too can offer the potential substantial growth over the long term.

FAQs:

Can mutual funds perform better than the stock market?

Actively managed mutual funds seek to perform better their benchmark index in the long term. This benchmark index, in turn, is made up of stocks. So, in that sense, mutual funds that are actively managed seek to perform better than the corresponding stock market segment. However, a more concentrated stock portfolio can deliver higher return potential than diversified mutual funds, albeit with significantly greater risk.

Is it less risky to make an investment in mutual funds rather than in individual stocks?

Yes, mutual funds are generally less risky than individual stocks due to their diversified nature. They spread risk across multiple assets, reducing the impact of a single underperforming investment. Moreover, they are managed by investment experts, who make buy and sell decisions based on extensive research and experience.

How long should I invest in a mutual fund to earn a good return on investment?

There is no single suitable time frame. Generally, the longer the horizon, the higher return potential, owing to the power of compounding in the long term. So, for equity funds, an investment horizon of at least five years or more is generally recommended.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.