Direct Equity Investing vs. Investing in Mutual Funds

History has shown us that equities have been the most rewarding investment, asset class over long-term horizons. It has potentially generated tremendous wealth for investors. As more and more investors realise the potential and need for equities in their portfolio, they are faced with the choice of either investing directly into equities or investing through equity mutual funds. Which is better? What should I do? This article answers that question.

What do you need for direct stock investment?

1. Time to research stocks: Studying the share markets is a full-time activity and requires a lot of time and energy on part of the investor. You would also need to analyse economic numbers and macro-economic factors like government policy changes, global impact, currency, etc. You should probably leave your day time job /business to do that.
2. Market Expertise: One needs adequate skills and expertise in managing investments. Since too much information is readily available, true skill is to know what is important and to analyse the same and assess the impact on the stock prices. This is not which you can learn easily but comes only with experience, involvement and intelligence.
3. Research affordability: There are a cost and time factor involved in research and study. The time is something which carries huge costs but is unfortunately not often measures by small investors. Such costs are justified if your investment capital is small or if you are a small-time investor.
4. Unbiased and emotional control: It is a fact that a very large majority of equity investors haven't created much wealth from stock investing. Faulty investor behaviour is the culprit when it comes to less than optimum returns from markets even though the markets have performed very well in long-term. Can you claim to be unbiased to your stocks, remain unaffected from daily news and stock movement and not be carried away?

What you will not get with Mutual Funds investments?

1. Excitement and thrill (or worry) of stock movement: Let's admit it. Direct stock investment is exciting and thrilling. It is like T20 and if you wish to be always preoccupied with markets, like the excitement of uncertainty, direct stock investments may be your preference. Mutual fund investment would be like a test-match, it is boring and not exciting enough for you.
2. Full control over investments/stock selection: In mutual funds, there is someone else who is taking the stock investment decisions within the ambit of the scheme objective. You have no control if you want HDFC bank instead of a Yes Bank in your portfolio.
3. Ownership rights: With direct stock investing you become a part-owner of the company and get ownership rights. In a mutual fund, you do not get that sense of ownership since underlying stocks are 'indirectly' held by investors through the fund house.

But what you will get with mutual funds investments?

1. Professional management: In mutual funds, the investor leaves this task to the fund managers who are professionals in their field and manage the investment on behalf of the investors.
2. Portfolio diversification: With mutual funds, you have very good diversification. Even if a stock goes bust, you are not much affected. As opposed to this, if you had been invested in that stock directly, you would have likely suffered a huge loss.
3. Diversification at affordable cost: With just a few hundred rupees, one can invest in over 20-30 companies. This is because MF units have are priced at affordable NAVs derived from the entire portfolio. You may be owning highly priced stocks which may not be possible In direct equity investing, Also, such level diversification will not be easy to achieve in direct investments with low capital.
4. Economies of scale: Mutual funds enjoy great economies of scale for their entire research, fund management and administration costs. These are passed on the investors as the fund size or AUM grows in the form of lower expense ratios. Expense ratios are the only cost which the investors pay and it is clearly known in advance.
5. Investment management tools: Mutual funds offer many tools like SIP, growing SIP, STP, SWP, dividend payout, dividend reinvestments, insta cash, etc which can be smartly used by investors to manage their portfolio and cash-flows. Such multiple tools are not available at the disposal of direct stock investors.
6. Tax benefit: Of course, equity mutual funds enjoy similar tax treatment as direct stocks. However, equity-linked savings schemes or ELSS gets counted in your 80C investments. This benefit is not available in direct stocks.
7. Budget-friendly: For most of us, we are concerned with the investible surplus we have. With mutual funds, you can however relax and start saving with as little as Rs.500. There is no upper limit though.
8. Ready portfolios as per strategy: There is a huge choice of funds which follow different objectives and strategies in their preferred universe of stocks. There are ready portfolios like large-cap /mid-cap /blend /value /contra /sectoral or thematic fund, etc to suit one's risk appetite and strategy.
9. Choices for asset allocation: Moving beyond equity funds, there are funds offering every possible combination of equity and debt assets. Thus, even while you may be investing in a single fund, you may have a matching asset-allocation to your risk appetite. This is something you will have to manage separately in your portfolio.

To be fair, both mutual funds and direct equity have their pros and cons. What is more important is to know what you are looking for, what you are capable of and how much time and efforts you can put to it? Obviously, most of us are preoccupied in our lives, job, business, etc to devote quality time regularly only to investments, even assuming you have the necessary skills & knowledge. Investment in stocks is thus recommended only to those investors who not only are great researchers having expertise in markets but also willing to go put in the efforts. For the majority of us, mutual funds offer a much better trade-off where you can hire such proven experts in the industry for a small fee. When we look at the benefits offered, obviously we can safely say that equity mutual funds are the ideal vehicles for investing in stocks.