Investing in Mutual Funds vs Stocks is the biggest dilemma an investor faces when starting market-linked financial investments. For investors looking for high returns, investing in stocks may seem an attractive option as compared to mutual funds. With the stock investment, the chances of getting high returns are high but it also involves a high risk quotient.
Whereas, investing in mutual funds involves lesser risk as mutual funds have a diversified investment portfolio that mitigates the market risk. Moreover, the trading cost or brokerage associated with buying and selling of the stocks can add a huge amount while investing in mutual funds, investors can save up on these costs as equity-related instruments in mutual funds are bought and sold in bulk, reducing the cost incurred by the investor.
Before we dig deeper into the discussion of Mutual Funds vs Stocks to find which of these is a better investment choice, let’s understand both separately.
What are Stocks?
Stock or equity is a security representing the ownership of a fraction of a company. It entitles the owner to a proportion of the company’s profits and assets equal to the number of stocks the investor owns. The units of the stocks are called shares. Mainly, stocks are sold and bought on stock exchanges.
Returns on Stocks
Investors earn returns from stocks in two different ways:
- Selling stocks at a profit
- Through annual or interim dividends
The profit is the difference between the selling price and buying price subtracting the trading cost or brokerage.
What are Mutual Funds?
A mutual fund is a type of investment vehicle that consists of a pool of money from different investors to invest in equity, bonds, and other investment funds. The professional money managers operate mutual funds to allocate assets with an aim to generate capital gains for the investors. The portfolio of the mutual funds is maintained to match the investment goals and objectives of the investors.
Returns on Mutual Funds
A mutual fund uses a pool of money from various investors with a mutual objective. The returns depend on the market situation and portion of your contribution.
The returns on a mutual fund investment mainly depend on the type of fund you invest in or the level of risk you want to take. If you are a conservative investor then you would like to invest in debt based mutual funds whose returns are not on the higher side which however is not true for equity funds but also implies taking on higher risk.
Mutual Funds vs Stocks: Which is Better for Beginners?
Let’s consider two investors A and B. Investor A has a full-time job and doesn’t have a lot of time to spend on researching different stocks and neither has prior knowledge of investing in them. On the other hand Investor B is highly interested in researching companies and understands the working of companies in the FMCG sector.
In such a scenario, given both are new to investing it would be better for Investor A to invest in a mutual fund scheme based on how much risk he is willing to take and as per his goals with proper diversification into debt and equity funds which will shield in case of potential downturns and volatility in markets.
For Investor B, given his interest in researching companies it would be better to invest in stocks, given that he understands the companies or stocks that he chooses to invest in. Also, the role of diversification can’t be underestimated here as well given that stocks are prone to high volatility. Hence investing in a single stock or single sector can be dangerous and hence investing small portions of your total investment in different stocks across various sectors is highly advisable.
Mutual Funds vs Stocks: Which gives a better Return
Here is a comparison between returns of Top Mutual funds vs stocks over 3 and 5 year time horizons to help you compare them over longer periods of times:
Top Performing Mutual Funds in India
|Fund Name||3-Year Return (%)||5-Year Return (%)|
|CR Bluechip Equity Fund – D (G)||15.7||17|
|Axis Bluechip Fund – D (G)||16.4||17.4|
|IDFC Bond Fund – LTP – D (G)||10.3||9.7|
|CR Equity Hybrid Fund – DP – (G)||12.4||14.1|
|CR Equity Hybrid Fund – RP – (G)||11.1||12.8|
Top Performing Stocks on Nifty Index
|Stock name||3-Year Return (%)||5-Year Return (%)|
|HDFC Bank Ltd.||25.75||25.26|
Mutual Funds vs Stocks: Difference
Here are the key differences between mutual funds and stocks:
Cost of Investing
- To invest in stocks, investors need to have a Demat account while for investing in mutual funds, a Demat account is not necessary. However, if the investor has a Demat account, it can be used to manage the mutual funds’ portfolio.
- You can open your Demat account by filling this form.
- As mutual funds are a portfolio of shares of various companies pre-determined or changed by the money manager, an investor doesn’t have any control over the choice of stocks or trade. Also, an investor cannot exit from a certain stock even if he/she wishes to.
- Mutual funds are managed by the money manager in AMC. The external management of a mutual funds portfolio ensures that the investors are involved directly except while choosing the type of funds to invest in. As mutual funds are managed by professional money managers, it is the best option of investment for new investors who have very little or no knowledge of the stock market.
- On the other hand, investment in shares requires a strong knowledge of the performance of the company along with the stock market. Stock investment is a hands-on activity that involves market decisions and is suitable for investors with a great knowledge of the stock market.
Active v/s Passive Investment
- As mutual funds is a passive way of investing in the market, it is easy for everyone to invest in it. While stock investment requires more dedication and time to generate desired returns.
SIP v/s Direct Investment
- Investors can invest in mutual funds through a monthly Systematic Investment Plan which allows investors to invest a monthly sum which can be a great way to diversify risk
- One cannot make such investment in stocks as the price of the shares continuously fluctuates and requires attention and swift trade decisions and investments in stocks can be risky and hence, investments should be made in different stocks.
- As you know mutual funds hold a diversified portfolio, stocks with negative returns can be cushioned by the other shares that are performing well. For example, if your mutual fund invests in 20 different stocks, out of which 2 are giving negative returns, even if the remaining 18 stocks show the slightest growth, these stocks can cushion the overall value of the fund.
- If an investor chooses to invest in stocks, such type of protection is not available, making your investment highly volatile. Unless your portfolio has several different stocks, your money will be at a huge risk.
- When investing in mutual funds, remember that you will have to give the funds at least 5-7 years to generate good returns as these have a long-term growth trajectory. In the case of stocks, you can get quick and good returns if you choose the right stocks and sell them at the right time.
- Note that you are levied with short-term capital gains tax at the rate of 10% if you sell your stock holdings within one year from the date of purchase. On the other hand, there is no tax on capital gains on the stocks that are sold by the fund. This is a substantial benefit for you. The tax saved is also available for you to invest in further, thus making way for further income generation through investment.
Through our comparison between Mutual funds vs Stocks, we can conclude that investing in mutual funds is a better choice as compared to investing in stocks. As investing in mutual funds involves lesser risk, it is a better option for a new investor who aims for steady growth. However, if you are a stock market expert and can invest your time in the stock market, you can invest in stocks for better returns.