Stocks or mutual funds: What do you prefer?

Investing is the action of buying an asset with the aim of making profits and earning income. Contrary to what many people believe, investing is a long-term activity, while trading is a short-term activity. A successful investor takes a look at the fundamentals of the asset before putting down his money to buy the asset.

We all know that investing in equities is the key to build long-term wealth. The two methods of investing in equities are either directly or indirectly. Direct investment entails purchasing stocks directly, while indirect investment entails investing in mutual funds that in turn invest in stocks. So what is investing and how does the investing in stocks differ from investing in mutual fund? What are the pros and cons of both the options?

Definition of investing: Investing is the action of buying an asset with the aim of making profits and earning income. Contrary to what many people believe, investing is a long-term activity, while trading is a short-term activity. A successful investor takes a look at the fundamentals of the asset before putting down his money to buy the asset.

Differences in investing in stocks vs mutual funds: There are many differences between investing in stocks and mutual funds. Here are the major differences between them.

Stocks Mutual funds

S: Need a demat account for buying and selling

MF: No need for demat account, except for buying and selling ETFs

S: Must be traded through a broker except in case of IPO

MF: Can be traded through a financial broker or directly by approaching the fund house

S: You are the part owner of the company, making you eligible for bonus shares, voting rights etc.

MF: You don’t own shares directly, so you are not eligible for any rights due to the owner

S: You get dividend if the company makes the profit Dividend is optional and if chosen will affect the value of your investment by the amount of dividend declared.

MF: You have to keep a check on the performance of your holdings Expert fund managers take care of all the activities

S: The charges incurred here are the demat charges, and buying/selling charges (only when the transaction takes place)

MF: There is an entry load, exit load, fund management charges and buy sell spread. These charges can significantly affect the returns generated by the fund.

S:Price of a share can be very volatile.

MF: Normally the NAVs do not show a significant rise or crash

S: Need a lot of money to diversify.

MF: Diversification can be achieved with amounts as low as Rs. 5000 (or even lesser in case of ELSS).

Pros and cons of both the types of investment:

Stocks:(Pros Cons)

You are the owner of the company Higher risk since if the company closes down, you tend to lose money Can earn dividends, which may be your source of income The fortunes of even the most profitable companies can change suddenly, so you stand to lose the dividend.

You can buy/sell in the stocks at the price of your choice by using the option of stop loss Your stop loss may not be reached, making it difficult for you to trade in the stock. Suitable only for experienced investors.

Is time consuming as you need to study the fundamentals of the stock, Diversification needs a lot of money which is not possible for small investors, May not be liquid, particularly if the company is small or mid-cap.

Mutual funds: (Pros Cons)

Managed professionally You end up paying the charges for availing of this expertise

Diversification can be achieved with nominal amount of Rs 5000 You don’t have a say in deciding where your money is invested. The fund manager decides for you and he may be wrong, thus causing a loss. Very liquid You have to pay exit load if you redeem your investment before a certain time frame

Can be purchased directly thus saving you from having to pay entry load High fund management expenses can erode the returns. Unlike companies, mutual funds will not close down. Rather they would be merged into another successful fund. Tend to be mis-sold by the mutual fund advisors as well as fund houses.

While both mutual funds and stocks have their own distinct features, it is up to each individual investor to decide where to invest. For those who have time, expertise and money, direct investing can be done. For others, mutual funds are the way to go. In fact, some funds have managed to outperform their benchmark index. However one important point to be noted is that both are long-term investment options.