Equity Mutual funds invest in stocks of publicly listed companies. You as an investor also have an option to buy these stocks directly from the stock market.

Both has its advantages and downsides, here is what you should know about investing in both avenues. And how you can make your selection.

What Are Mutual Funds?

Mutual fund (MF) scheme, issued by mutual fund houses, pools money from various individuals who wish to save or invest. The fund houses then invests the money collected across various financial instruments to generate high returns. The MFs are professionally managed.

So basically, you as an investor own units that represents the portion of the fund you hold. The investor is also known as an unitholder. The increase in the value of the investments along with other incomes earned from it is then distributed to the unitholders in proportion to the number of units owned. This is given after deducting applicable expenses.

What is Direct Equity?

Direct equity investment can be very rewarding, however, the risk of loss in direct equity is also very high. It is not easy to understand equity. One needs to understand the underlying business and industry the business operates in, before investing in equity (stocks).

This means, you as an investor have to go through company’s past records, financial performance, management experience and even external factors such as Government policy, foreign exchange rate and political changes both domestically and internationally.

If you can balance find the right balance between risk and return, you can reap greater benefits.

Direct Equity vs Mutual Funds

There are various benefits of investing through mutual funds which may not be available if one invests directly through shares.

While direct equity investing provides high returns, it is feasible for those investors who can understand the working of equity markets regularly.

So for those who don’t have the time or skill to monitor equity or share markets, mutual funds route could be better and beneficial.

Some of the advantages of mutual funds are as follows:

  • Professional Management

Individuals may not have the necessary skills to identify the right stocks. Not everyone can dedicate time to do research. Mutual funds, therefore, offer investors the expertise of fund managers.

  • Low Ticket Size

As some shares quote very high prices, they remain inaccessible for small investors. However, one can start investing in mutual funds which invest in various stocks with as low as Rs. 500.

  • Fees & Expenses

For their services, mutual funds charge fund management fees and expenses which are capped under the regulation.

If an investor wants to trade in equities he/she need not pay for the DMAT or trading charges. However, investors should be careful not to buy funds with very high expense ratios.

  • Liquidity

Open-ended funds allow investors to exit at the prevailing NAV, subject to exit loads. This helps in financial planning. When an individual invests in shares, he is not sure if he can sell the shares in the market at a fair value or not.

  • Risk Management

An individual may go overboard on a particular stock. However, a fund manager will have risk management guidelines in place.

There are limits on how much a fund manager can invest in each stock &  sector. A fund manager’s decision to invest in a particular share is backed by strong research conducted by the fund manager & his/her team members.

  • Choice Of Funds

Investors can choose to invest in a scheme that suits their investment needs. For example, an aggressive investor may choose to invest in a diversified equity fund, whereas a less risky investor may opt for a balanced fund.

  • Taxation

When an individual investor buys & sells shares before completing the tenure of 1 year, he ends up paying short-term capital gains. However, the fund managers may keep transacting in shares at varying intervals.

If the investor remains invested for more than 1 year in an equity fund, his gains are totally tax-free since STT (Securities Transaction Tax) is already deducted.

A Short Story with Mutual Funds

How can Shashank use the Mutual Fund route to earn more?

Shashank wants to invest Rs. 1,000 in 5 stocks. Since the collective investment in mutual funds would work better, he approaches 5 of his friends – Harish, Lokesh, Manish, Shailesh & Kumar. While the first 3 are keen to invest Rs. 1,000 each, Shailesh & Kumar agree to chip in with Rs. 500.They appoint Santosh as their fund manager.

Santosh collects Rs. 5,000 in total & issues units of Rs. 10 to each of them. This gives Shailesh & Kumar 50 units each whereas others get 100 units . As the fund manager, Santosh buys one stock of each blue-chip stock on January 1.

At the end of the month, the prices of these stocks change & the portfolio value increases to Rs. 5,250.  Santosh charges 1.5% from the returns for his services as a fund manager.

Had the share prices fallen, the valuation of the investments would have fallen as well.

On the other hand, if each of them had separately invested in a blue chip company (stock) which was around Rs 900. Shailesh and Kumar couldn’t have even participated.

Making a decision

  • Do you Understand Equities?

One of the most important factors to invest in mutual fund and equities is to answer a question – do you understand equities? How to know whether you understand equities better or not? Do you understand the underlying business and how it earns money? Can you figure out the fair value of that business?

If the answer to any of these questions is NO – equity is probably not for you.

  • Do You Have Time to Trade and Track Stocks?

Another important factor which you should consider before investing in mutual funds & equities is to answer this important question – do you have time to trade & track stocks?

If you cannot monitor your portfolio and time your exit then your investment may not reap the reward you expect.

  • Behavioral Biases

Many individuals start direct investments but lack the discipline to continually allocate time to make investment decisions. If you face similar issues, you should consider investing in mutual funds.

The process is simple. You have to set-up a monthly systematic investment plan(SIP) on mutual funds that you think is appropriate for your investment goals.

It is also behaviorally optimal to meet your life goals through mutual funds. Why? Direct investment requires active decision making — when to buy & sell shares. You can buy shares at a lower price or sell shares at a higher price.

SIP on mutual fund helps you distance yourself from active decision making. Besides, index funds do not have the risk of under-performing the market, as they are designed to mimic the market.

  • Long-term and diversification

If you want best of both worlds then you need to invest for long-term. Atleast for a minimum period of 3-5 years. This can give the desired returns from an investment – be it MFs or stocks.

However, when it comes to stocks, it will be difficult to time your exit while in MFs, you can exit in a certain period.

Another way to go about it is, even if you don’t want to take a risk, invest a small portion of your investment in equities and balance in MFs. That way, you get the benefits of both investment avenues. And your risk is capped as you only have small exposure to equities.

Companies such as Groww helps new investors get started without any hassles.

Disclaimer: Views expressed here are of that author. Mutual fund investments are subject to market risks, read all scheme related documents carefully.