Where can I get better returns which can beat inflation?
The answer for both the questions is investing in stock market. Once you decide to invest in stock market, you have got two options. The option one is to invest directly in stock market and the option two is to invest through mutual funds.
Which Option to Choose?
Each of the options has got its own pros and cons. Depending upon your requirement and situation, you need to choose the right option. The following points will enlighten you on both the options and will also help you understand and check the factors to be considered before choosing the right option.
Comparative analysis between Direct stock investment Vs. Investment in stocks through Mutual Funds
1. Investment Knowledge and Expertise required: Direct Stock Vs. Mutual Funds
Investing directly in stock market definitely demands a good amount of knowledge and expertise. You should know how to read a balance sheet, analyse a company, choose a right company to invest, analyzing the sectoral trends, constructing a portfolio, stock valuation…
If you are comfortable doing all these things, then you have qualified the first criteria to invest directly in stock market. If you are not comfortable doing all these things, then you can opt to invest through mutual funds.
There is a fund manager in mutual fund who is an expert in equity investments. He along with his team of analysts will take care of investing in equities. As these fund managers are managing funds of many investors, they have crores of money to invest in equity market. Average size of an equity fund is 1000 to 2000 crores. As they are handling huge money, they do sophisticated research, buy research reports from various economic research bodies, and directly interact with the management team of the company before making investment into a company. It is not possible for an individual investor to do all these things.
2. Time required in researching and monitoring your investment: Direct Stock vs. Mutual Fund
Are you a time rich person? If you have answered yes, then you can think of investing directly in stock market. For doing stock market analysis & research, market watch, portfolio review, demands a lot of time.
Also as a direct stock market investor, you should have access to the market anytime. At times, there may be some sudden news or major stock market movement. Because of that you may need to make some investment decisions immediately. You need to react on time on those occasions. Investing directly in stock market is a time sensitive game.
Is it worth your time? During a stock market working day, you need to spend at least 2 hours on the stock market in order to be a successful investor. Instead of spending 2 hours everyday in the stock market, if you spend the same on your own business or profession or career, will you make more money?
A doctor may be able to earn more if he spends those 2 hours in his practice in instead of spending it on the stock market. It depends upon how much money you invest and how much return you make in the stock market vis-à-vis how much money you make in your profession.
If you are not a time rich investor, then you can choose mutual funds route for stock market investments. Here you will be spending very minimal time, but you will get almost similar returns to direct stock market investments.
Emotional Engagement
There are 2 set of investors. One set of investors will invest in the stock market to make money in the stock market. There is another set of investors who will also claim that they are in the market to make money but actually they are in the market because it emotionally engages them.
Let me explain. When you are travelling in a car driven by a driver, it will not emotionally engage you. But when you are driving the car, it will emotionally engage you. It will emotionally engage you when you are overtaking another vehicle, when you are driving at 100Km per hour speed… It gives you a kind of thrill when you are self driving.
Similarly when you are investing directly, it also gives you a thrill. You will feel happy when the share you have selected has gone up. There will be a sense of achievement when you sold a share at profit. This is what I call it as emotional engagement. Instead of investing to make money over a period of time investors, invest directly for the kick or thrill of emotional engagement.
Remember. You need to be rational when it comes to money management. If you are emotional, that will spoil the entire game.
Emotional Maturity
Are you emotionally matured? This point is just a continuation of the last point. As this one needs more emphasis, I am giving it as a separate point.
Many investors go crazy when the market goes up by 50%. They will invest 100% of their savings in the stock market. They also lose their heart when the market goes down by 50%. They will immediately book loss.
Because of emotional immaturity, investors invest more, when they are supposed to book profit. They book loss, when they are supposed to invest more.
If you are an emotionally well balanced person and a disciplined investor, then you can go ahead invest directly in stock market. Otherwise mutual funds will be your best choice. The fund managers in mutual funds take very rational decision. They are process driven and emotionally well balanced.
5. Automatic payment in Investment: Direct Stock vs. Mutual Fund
There are various well-evolved and standardized ways to invest in mutual funds, the most popular way of automatic investing is called SIP (Systematic Investment Plan). It provides you a great way to automate your investing without the hassle of investing manually every month. Automatic payments per month develop a habit of regular investing.
However, when you buy stocks, you have to manually invest in each stock every month if you want to regularly invest in them. Though there are few stocks that allow automatic investment through SIP; but they are very few!
Manual investment is practically difficult and the majority of the investors invest when they feel like investing or they wait and time the market for their ideal investment, this way they fall apart in the investment process.
6. Tax Benefits in Investments: Direct Stock vs. Mutual Fund
Mutual funds provide the tax-saving benefits if you invest in ELSS (Equity Linked Saving Scheme) according to the tax law 80C.
Whereas, direct investing has no tax benefits.
7. Diversification in investment: Direct Stock vs. Mutual Fund
If you invest in a single Mutual Fund, your investment is diversified across various stocks. So, even if one or two stocks are not performing well, the others will compensate for it. And, the returns generated will be approximately uniform.
Whereas, let’s say if you invest in a single stock, your investment is solely dependent on the performance of that particular stock. If it performs well you will get good returns and if it doesn’t perform well, you will lose money!
8. Fees and additional costs: Direct Stock vs. Mutual Funds
Mutual fund investing involves the additional cost included in NAV, known as the Expense Ratio. The expense ratio in the equity funds varies from 2-2.5%.
Direct stock investment doesn’t have expense ratio charges, but they have Demat Account charges along with STT and transaction charges. These charges are very small as compared to the expense ratio.
But, in Mutual Fund investment you have a professional Fund Manager, who handles all your investment. So there is nothing wrong with paying the fees called expense ratio if you are not confident in generating higher returns in the Direct Stock investment.
In Nutshell
| Investment in Direct Stock | Investment in Mutual Funds |
|---|---|
| More investment knowledge and expertise in understanding businesses are required. | Expert Fund Managers have all the required knowledge and expertise. They handle your funds, so you don’t need to be highly skilled. |
| More time is required for analyzing, researching and monitoring the stocks. | Time is significantly saved. As most of the tasks are carried out by experienced fund managers. |
| Good investment experience and Emotional Balance is needed, as the stock investment is extremely volatile in nature. | There’s no investment experience required in Mutual Funds. All it requires is little emotional balance and courage to stay invested for long term |
| As it emotionally engages you, there is a possibility of your emotion misleads you and you may take a biased decision. | As it is managed by a professional fund manager, no room for bias. |
| Automatic payment is not possible with most of the stock investment. | Automatic payment is a well-evolved trend in Mutual Fund investment with various different options to invest, such as SIP, STP, etc. |
| No Tax Benefits | Tax Benefits under 80C, through ELSS Scheme |
| Your investment is not diversified, so there are no diversification benefits. | Your investments are well diversified among various stock units. Therefore, provides good diversification benefits. |
| Direct Stock investment has a small fee in terms of Demat Account and they don’t have any expense ratio charges. | Mutual Funds incurs expense ratio within the range of 2%, included in the NAV amount. |
Final Selection
Based on the above 4 parameters, you can choose between investing directly in stock market and investing through mutual funds. If you are considering these parameters, you will break the records in the stock market. On the other hand if you are not considering these parameters, you will break yourselves in the stock market.
If you choose to invest in stocks through Mutual Funds, then you should read this article for better clarity on “How to Invest in Mutual Funds?” However, if you are investing directly in stocks, then you should consider reading this article for more details on “How to Invest in the Stock Market?”
To be successful in stock market you should not chase returns, you should chase to achieve your goals. To achieve your life financial goals, you need to create a strong financial plan.
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