Mutual Funds vs Direct Stocks: Which is Better?

Tenet 3: Mutual Funds over Direct Stocks

In our previous editions of Weekend Bytes, we have been discussing various tenets that you can adopt to reduce risks while investing in equities, namely, tenet 1 – Diversification and tenet 2 – Thinking Long Term. In this edition, we discuss tenet 3: Opting for Mutual Funds over Direct Stocks.

Scott D. Cook once quoted – “Mutual funds were created to make investing easy, so consumers wouldn’t have to be burdened with picking individual stocks!”

While equities have the potential for long-term wealth creation, investors do tend to get drawn by short term fluctuations in the market and may commit mistakes including:

• Market timing – buying and selling based on short term price movements
• Emotional investing – Making decisions driven by emotions including greed and fear / panic
• Inadequate diversification – Concentrating large investments into too few stocks or similar set of stocks
• Neglecting to do research

Trend of Investors investing directly in the Stock Markets

In recent times, we have seen an emerging trend of millennials investing directly in stock markets. This is evident from the multifold rise in the number of demat accounts opened.

In the recent past, a higher number of retail investors have invested during an up-trending market. A similar example of this trend was seen during the bull run of 2003-08. However, after the sharp fall during the Global Financial Crisis, such investors found it difficult to re-enter the equity markets because of the fear of loss. While apps have made trading easier, direct investing is more complicated than expected.

Wide dispersion of returns in equities makes a case for investing through MFs!

While it may be tempting to invest directly in stocks, the divergence of returns across companies makes direct investing an endeavor fraught with risk. If one considers 5 year returns of NIFTY 500 companies (As of 31-Dec-22), while 95 out 402^ companies yielded returns above 20% CAGR, almost an equal number of companies yielded negative returns (110 companies). A quick look at the below table shows the extent of return dispersion in equities. Such wide dispersion in equity returns makes stock selection extremely critical.

In view of the above, it is prudent to invest in equities via MFs, which have a well-diversified portfolio and professional fund management expertise.

Conclusion

While diversification and thinking long term are key tenets to reduce risks while investing in equities, investing in mutual funds over direct stocks is also key tenet to reduce risk, while ensuring investing discipline. Why so?

But are there more techniques to reduce risks while investing in equities?

Tune in for the next edition of this series to know more!

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.