One good transformation noticeable in India today is that savings of households is not entirely going to fixed income instruments such as PPF, Post Office Savings Scheme, fixed deposits etc.
This one way is fruitful, but on the other hand, we, as investors face this dilemma quite often whether to invest our hard earned money in stocks or mutual funds.
Every product has its own pros and cons and in this article, we will try to solve this dilemma.
Stocks (Equity), as we all know are shares which entitle us to be the part-owners of a company.
Mutual Funds on the other hand, is an investment led by professional managers and comprises of a pool of money collected from various investors for the purpose of investing in diversified securities.
Therefore, when we compare both the products on a risk factor, stocks happen to be far riskier than mutual funds.
Let us now discuss various parameters based on which investors can opt either stocks or mutual funds.
Let us now discuss the kind of investors that choose these particular products.
Investing directly into equities is not an easy task and therefore, it is not advisable for beginners. People who have mastered the art of investing in stocks have only achieved it by losing or failing in the early stage of their investing career.
Therefore, until and unless we are very sure to put in a great deal of zeal and hard work to learn and capture the nuances of markets we should not jump into equities directly. This path is followed mostly by people who have higher risk appetite than others in the markets.
They can again be segregated into two buckets- Traders and Investors. In simple words, traders are short term players in the market, whereas investors tend to be in the markets for long term.
Both types have higher risk takers. This does not mean that we cannot make money while directly investing in stocks but going by past records we see that only a small proportion of the investors have been able to beat the markets consistently over a long period of time.
The case of traders is also different wherein the downside risk is even greater.
The riskometer in case of mutual funds does not tend to be at the extreme end, as in the case of stocks but slightly below or middle based on the type of funds we opt for.
For example: Direct equity mutual funds have a higher risk as compared to balanced funds which comprise of both equity and debt part.
Let’s say we purchase an equity mutual fund from Reliance Mutual Fund. The number of stocks invested by this fund is around 30-35 which is a good mix for both large and mid-sized companies, therefore, the risk is totally diluted or distributed among all the stocks proportionally, or we can say that they follow a disciplined diversification.
Therefore, the riskiness in case of mutual funds can be managed in a better way by professional management and so it is best fitted for those who are new to the markets or do not want to take unnecessary risks (having lower risk appetite).
Note: We can segregate investors based on the risk appetite and thereby can choose the instrument which deems fit
Looking at the returns for the various top mutual funds and stocks will give us a fair idea about choosing which way to go.
Neglecting the 1-Year returns for these products (because of the volatility seen in the markets lately which has led to significant correction in most funds and stocks); we see that equities have outperformed mutual funds in the long run.
This is where the risk-return tradeoff theory comes into picture.
Mutual funds wherein the risk involved is less that stocks, likewise the returns are also less. But returns by no means can be considered low.
We can see most mutual funds providing more than 15% returns consistently, therefore, can be considered a great product for marginal investors who do not want to ride the difficult storm of investing into equities directly.
Also, a common feature that can be seen in both these products is that of time frame for generating returns. For example, let us consider Mr. A who has invested in Mirae Asset Emerging Bluechip Fund and makes a direct investment into the stock of Maruti Suzuki for an investment horizon of one year, whereas on the other hand Mr. B who makes a similar investment but with a time horizon of 5 years.
The returns generated for both these investors would be drastically different which can be highlighted in the chart below:
|Investor||Returns (Mirae Asset Emerging Bluechip Fund)||Returns (Maruti Suzuki India Limited)|
|Mr A (1-Year)||-4.2%||-13.29%|
|Mr B (5-Year)||29.0%||34.62%|
The above chart provides us with the benefits of long term investing and therefore it is recommended for all investors for follow this route for greater returns.
We can also think from the angle of taxation while deciding to put our money into stocks or mutual funds.
This year in the budget, Finance Minister announced levy of taxes to the tune of 10% on profits made on sale of equities (only if the profit amount in a financial year exceeds INR 1 lakh).
Also, let us discuss below the tax structure in case of mutual funds:-
Mutual Funds can be categorised into the following:-
i) Short Term Capital Gains- If the holding period is less than one year;
ii) Long-Term Capital Gains – If the holding period is more than one year;
However, in case of debt mutual funds it can be categorised as shown below:-
i) Short Term Capital Gains- If the holding period is less than three years;
ii) Long Term Capital Gains- If the holding period is more than three years;
|Stocks and Equity Oriented Mutual Funds (Individuals)|
|Long Term Capital Gain Tax (LTCG)||10% above a gain on Rs. 100,000|
|Short Term Capital Gain Tax (STCG)||15%|
However, a particular kind of mutual fund named ELSS (Equity Linked Savings Scheme) falls under the ambit of Section 80C of the Income Tax Act, 1961.
Therefore, an investor wanting to invest for long-term in a medium risk product can go for ELSS which has a minimum holding period of 3 years.
The amount of tax that can be claimed is upto 1.5 lakhs per assesse.
It’s all about the money!
Let’s discuss the funds to be set aside in each case. Though we can start with a small amount in bot these products, in order to generate a fairly better return, the amount to be put in case of stocks should be higher.
However, the concept of Systematic Investment Plan (SIPs) comes to the fore in case of mutual funds whereby the amount of investments can be as low as Rs. 100 per month in many schemes.
Therefore, a marginal investor can easily invest in such schemes without feeling the pinch in the pocket.
Based on the various buckets (risk appetite, returns, taxes, amount to be invested) that we discussed, investors can make a sound decision where to put their money in.
Mutual funds can provide us peace of mind when compared to stocks, but the amount of returns that can be generated by investing in equities cannot match that of mutual funds.
Finally, it goes without saying that the best returns would be generated only when the investors stick to his/her investments for the long term.
Which bucket do you fall in? Decide carefully.