Comparing mutual funds vs. stock trading - Which investment strategy is right for you?

Two of the most popular investment options for retail investors in India are mutual funds and stocks. But mutual funds and stocks have their own unique risk-return profiles, investment processes, and taxation rules. So how do you decide whether mutual fund investments or stock market trading is the better choice for you? Read on to find out.

• Table of contents

• Mutual funds definition
• Stocks definition
• Mutual funds vs stocks - Differences
• Pros of investing in mutual funds
• Cons of investing in mutual funds
• Pros of investing in stocks
• Cons of investing in stocks
• Choosing the right mutual funds
• Choosing the right stocks to invest in
• Mutual funds vs stocks - Which is a better investment?

Mutual funds definition

A mutual fund is a professionally managed investment plan that accumulates money from a large number of investors to invest in different asset classes such as equity, debt, gold etc. depending on the announced purpose of the fund. The fund manager carry out all the analysis, research and trading on investors' behalf.

Also Read: Stock SIP vs mutual fund SIP

Stocks definition

Stocks or shares represent ownership interest in a company. When you purchase a company's shares, you become a shareholder and part-owner of that company in proportion to your equity stake. Shareholders have a right to profits earned by the firm in the form of dividends and capital gains if the share price increases in value over time.

Mutual funds vs stocks - Differences

Pros of investing in mutual funds

• Professional management - Fund managers and research team handle all investments
• Diversification - Money invested across various assets and sectors
• Liquidity - Can redeem units at any time at applicable NAV
• Flexibility - Wide range of fund categories to match investment needs
• Low investment amounts - Allows small investors to participate
• Regulation - SEBI monitors mutual funds to protect investor interests

Cons of investing in mutual funds

• Costs - Expense ratio charged by fund houses eat into returns
• No control - Investors cannot influence specific investment decisions
• No guarantees - Funds do not assure returns and are subject to market risks
• Dependence on fund manager - Returns depend on manager's performance

Pros of investing in stocks

• Higher returns - Potential to earn higher returns compared to other assets
• Control - You decide which stocks to buy or sell
• Detailed research - Chance to thoroughly research companies of interest
• Ownership rights - Can vote on company matters as a shareholder
• Dividend income - Earn regular income through stock dividends
• Capital appreciation - Benefit from share price appreciation over time

Cons of investing in stocks

• Higher risk - Prone to significant market and stock-specific risks
• Volatility - Share prices can be very volatile in the short term
• No diversification - Concentrated bets increase risk
• Require expertise - In-depth knowledge needed for good stock picks
• Time consuming - Research and monitoring stocks requires time
• Higher investment required - Need sizable capital to create a portfolio

Choosing the right mutual funds

• Match asset allocation - Choose funds that help create a balanced and diversified portfolio as per your risk appetite and investment goals. Have a mix of equity, debt and hybrid schemes based on needs.
• Evaluate historical performance - Past returns give insight into the fund's consistency and risk-adjusted returns. Prefer funds with a good long-term track record.
• Check portfolio holdings - Analyse the underlying stocks/bonds/assets of the fund. Understand the investment strategy and portfolio concentration.
• Assess fund manager - Choose funds where fund manager has substantial experience in same category and has delivered good results.
• Compare expense ratios - Lower expense ratio means higher returns for you. Don't just chase past returns.
• Understand risks involved - Based on category, funds have different levels of volatility. Evaluate risks you can tolerate.
• Review ratings - Rating agencies rate mutual funds based on multiple factors. Choose highly rated funds in the category.
• Diversify your investments - To reduce risk, invest across different fund houses, fund managers and categories.

Also Read: Mutual Funds Vs. Stocks and Bonds

Choosing the right stocks to invest in

• Analyse company fundamentals - Evaluate sales growth, profitability, debt levels, management quality of potential companies.
• Assess valuation - Determine if stock is undervalued or overpriced based on P/E ratio, P/B ratio and other valuation metrics.
• Study competitive position - Understand the company's competitive advantages in its industry and barriers to entry.
• Favour companies with growth prospects - Find companies operating in growing sectors/segments and with visibility of future growth.
• Identify dividend-paying stocks - Seek stocks of companies with track record of consistent dividend payouts.
• Stay invested for long term - Hold stocks for long periods despite volatility to earn good returns.
• Diversify across sectors - Invest in stocks from different sectors to mitigate sector-specific risks.
• Analyse charts, volumes, trends - Use technical analysis along with fundamental analysis.
• Keep portfolio size optimal - 10-30 stocks helps balance diversification and returns.

Mutual funds vs stocks - Which is a better investment?

Mutual funds are better suited for beginners given their lower cost, diversification and professional management. You can start an SIP in 1-2 equity funds based on risk appetite. Hands-off investors prefer mutual funds, especially if you have limited time or experience for actively managing your own stock portfolio. Let the fund manager do the heavy lifting.

Conclusion

Usually, investing in both stocks and mutual funds after proper analysis will build a solid portfolio that has the highest return potential with minimum overall risk. The appropriate combination of investments varies based on your goals, horizon and risk capacity. Evaluate your circumstances, know the essential characteristics of each investment, and make wise choices for your future.

FAQs:

Which is safer, mutual fund or shares?

Mutual funds are relatively stable compared to buying individual shares for the average investor due to their diversified portfolio that mitigate overall risk. Even if some stocks do poorly, other holdings' gains help cushion the effect.

What are the different types of shares?

Major types of shares are (1) Equity shares reflecting ownership interest in a firm (2) Preference shares with prior claim on dividend and repayment but no voting rights (3) Blue chip shares of large-cap firms with good reputation (4) Income/dividend shares of established firms paying frequent dividends.

What is the difference between shares and mutual funds?

Shares are holding in one company. Mutual funds invest in a basket of shares, debt, cash and other securities. You purchase shares yourself, but mutual funds are managed by a fund manager.

Are mutual funds affected by the stock market?

Yes, equity-based mutual funds are influenced by the movement of stock markets since they invest mainly in listed company shares. If there is an increase in stock markets, the NAV of equity funds also increases and decreases inversely. However, diversification across stocks lowers overall volatility than individual shares.

Mutual funds or stocks—which one offers more security?

Mutual funds are relatively stable than direct investment in individual stocks. Even if a few stocks don't perform, other stocks in the fund cut down the portfolio effect. But stocks enable you to invest in only fundamentally good companies after thorough analysis. Thus, stock selection abilities are essential to growth and stability.