Difference between shares and mutual funds

In the ever-evolving world of investments, two popular options often come into focus: share and mutual funds. While they both offer opportunities to grow wealth and participate in financial markets, they differ significantly in their structure, mechanism, and potential outcomes.

Whether you’re a seasoned investor or a curious beginner, it’s essential to understand the factors that set these two investment vehicles apart. By understanding the difference between shares and mutual funds, you can make informed decisions regarding your investment.
But before we get into the difference between shares and mutual funds, it is important to understand them individually first.

• Table of contents

• What are shares?
• What are mutual funds?
• Mutual funds vs Stocks: A tabular breakdown
• Difference between shares and mutual funds
• Pros and cons of mutual funds
• How to choose the right mutual funds?

What are shares?

Shares represent a unit of ownership in the capital of a company. The ownership also entitles you, as a shareholder, to the profit as well as loss of the company. You can buy the shares of a company directly from your Demat account. Your stake in the company can be directly calculated by the number of shares you own as compared to the total shares of the company. Investors also bear the cost of trading and manage the owned shares themselves. In addition, investors must also find new companies to invest in regularly to diversify the portfolio and mitigate risk.

What are mutual funds?

A mutual fund is an investment vehicle that invests money in different types of securities such as stocks, bonds, and short-term debt in companies across different industry sectors. It pools money from different investors to purchase the securities. A key difference between shares and mutual funds is that investors do not need to manage this investment since a mutual fund is managed by fund managers. Moreover, the need for diversification is eliminated when you compare investing in MF vs shares, since a mutual fund invests in different securities across various sectors and companies.

Mutual funds vs Stocks: A tabular breakdown

Feature	Stocks	Mutual Funds
Definition	Ownership of a portion of a company	Pooled investment in a basket of securities (stocks, bonds, etc.)
Risk	Higher risk (individual company performance)	Lower risk (diversification reduces risk)
Return Potential	Potentially higher returns	Maybe lower than high-performing individual stocks owing to diversification.
Management	Self-directed (you choose which stocks to buy/sell)	Professionally managed by a fund manager
Diversification	A single stock is not diversified as it represents ownership in a single company.	High diversification (investing across multiple securities)
Liquidity	Generally high, but depends upon trading volumes (stocks are traded on exchanges)	Generally high for open-ended funds. Close-ended funds and those with a lock-in period have liquidity restrictions.
Control	More control over investment decisions	Limited control over investment decisions
Suitability	Suitable for investors with higher risk tolerance and market knowledge	Suitable for a wider range of investors, including those with lower risk tolerance

Difference between shares and mutual funds

Now that you know what are shares and mutual funds, you will be easily able to find the difference between shares and mutual funds. It will also help you know which of these is more suitable for you.

Investment knowledge

An important difference between shares and mutual funds is that you need to have a comparatively better knowledge of investing when you buy shares of a company. This is because you need to take buying and selling decisions based on price movements to turn a profit. On the contrary, since mutual funds are managed by experienced fund managers, even novice investors can reap the benefits of investing in mutual funds. The only thing an investor needs to do is find a suitable mutual fund scheme. They can also seek the help of a distributor for the same.

Risk level

Mutual funds are comparatively less risky than shares. This is simply because of the level of diversification and professional management offer by mutual funds. Many investors choose to buy stocks because they want to have control over their investment forgetting that it also exposes their investment to more risk.

Potential returns

Your potential of earning returns is better when you directly invest in the shares of one or more companies. The diversification offered by mutual funds, which aims to lower the risk factor, slightly affects your earning potential since the highs of some securities are absorbed by the lows of others. However, you must note that shares are typically considered to be relatively riskier than mutual funds.

Time spent

One of the major points in the shares vs mutual funds discussion is the amount of time you need to spend researching different stocks and then buying or selling shares depending on the market conditions. However, if you buy mutual funds, you can stay invested in the short, medium, or long-term basis your investment horizon. The fund manager will manage the fund on your behalf. You only need to monitor the performance on a regular basis.

Investment amount

You need a sizeable amount to invest in stocks. You may also have to diversify your portfolio by investing in shares of multiple companies. However, you can start with as little as Rs.1000 to invest in mutual funds through Systematic Investments Plans (SIPs). These plans allow you to get mutual fund units at periodic intervals to start building your portfolio even if you do not have a large sum of money.

Pros and cons of mutual funds

As with any investment avenue, mutual funds have certain advantages as well as disadvantages. Here’s a breakdown.

Advantages of mutual funds:

Diversification: Mutual funds invest in a variety of securities, reducing the risk of poor performance from any single asset.

Professional management: Skilled fund managers select and manage the investments on your behalf.

Accessibility: Mutual funds cater to investors with different risk levels and investment goals.

Convenience: Investments and redemptions are simple through various platforms (online or through distributors).

Affordability: You can start investing with small amounts, making them suitable for investors with limited capital.

Transparency: Regular updates on fund performance and portfolio holdings ensure clarity.

Disadvantages of mutual funds:

Expense ratios: Fees for management services can reduce overall returns.

Performance risk: Past performance does not guarantee future results; market conditions can impact performance.

Limited control: Investors have little influence over the fund manager's decisions.

Tax implications: Capital gains and dividends are taxable.

Market risk: Even diversified funds can be affected by market fluctuations.

How to choose the right mutual funds?

Choosing the right mutual fund involves evaluating several factors:

1. Define your investment goals

What are you saving for? (Retirement, education, home, etc.)

What is your investment time horizon? (Short, medium, or long-term)

What is your risk tolerance? (How comfortable are you with potential gains and losses?)

2. Assess your financial situation

Age and income: These impact your risk tolerance and investment timeline.

Existing investments: Review your current portfolio and identify any gaps.

Financial obligations: Account for any current financial responsibilities, such as loans or debts.

3. Research and select fund categories

Equity funds: Suitable for long-term growth but come with higher risk.

Examples: Large-cap, mid-cap, small-cap, sector, and thematic funds.

Debt funds: Generally lower risk, suitable for short to medium-term goals.

Examples: Liquid, short-term debt, income, and gilt funds.

Hybrid funds: A mix of equity and debt for a balanced approach.

Examples: Balanced, aggressive hybrid, and conservative hybrid funds.

4. Evaluate fund performance

Past performance is not indicative of future results, but trends over 3-5 years can provide insight. Consider the fund manager’s experience and approach. Review key metrics such as the Sharpe ratio, and standard deviation.

5. Compare expense ratios

Expense ratios represent the annual fees paid to fund managers.

Lower expense ratios can potentially increase net returns.

6. Diversify your portfolio

Avoid concentrating risk by diversifying across different fund categories and asset classes.

7. Regularly review and rebalance

Review your portfolio periodically to ensure it aligns with your goals and risk tolerance. Rebalance your portfolio as needed to maintain your target asset allocation.

Conclusion

In conclusion, both shares and mutual funds have the potential to generate inflation-beating returns over long term. The main difference between mutual fund and share market investment is your level of involvement. If you invest in a mutual fund, you can sit back and let the fund manager handle your money and generate returns. But if you directly invest in the share market by purchasing stocks, then you need to monitor your investment frequently to buy or sell stocks.

FAQs:

Are mutual funds called shares?

No, mutual funds are not called shares. Mutual funds are investment vehicles that pool money from multiple investors to invest in diversified portfolio of assets such as stocks, bonds, or other securities. The ownership in a mutual fund is represented by units, not shares.

Which is more profitable shares or mutual fund?

Comparing the profitability of shares and mutual fund is challenging as it depends on multiple factors such as market conditions, individual stock selection, and fund performance. Both shares and mutual fund can be profitable, however, mutual funds offer diversification and professional management, which can mitigate risk and potentially seek to generate long-term returns.

Which is safer, mutual fund or shares?

Mutual funds can be relatively lower risk than individual stocks due to diversification, professional management, and risk management strategies. They spread risk across various assets, reducing the impact of poor stock performance. However, risk levels vary by fund type, and there are no guarantees of returns, as market fluctuations still pose risks. For instance, equity-oriented funds are still categorised as very high risk, though they may be less risky than investing directly in stocks.

What are the different types of shares?

Shares represent ownership in a company and can be categorised based on different parameters, such as asset class, market capitalisation, investing, performance patterns and return trajectory. In terms of ownership, they can be classified:

• Common shares or equity shares: Carry voting rights and represent ownership in the company. Shareholders may earn dividends, but payments depend on profits.
• Preference shares: Shareholders receive fixed dividends and have priority over equity shareholders during dividend payments or liquidation but usually lack voting rights.

Is a stock called a share?

A share represents a single unit of ownership, while stock is a more general term referring to ownership of shares in one or more companies. Think of stock as the entire pie and share as a slice of that pie. Though often used interchangeably, this distinction highlights the difference in scope.

Which is better, share or SIP?

The choice between shares and SIPs in mutual funds depends on your risk tolerance, investment goals, and knowledge level. Shares offer higher potential returns but carry more risk and require significant market knowledge to select and manage. SIPs in mutual funds provide diversification, lower risk, and professional management but less control.

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 an 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.