Last Updated on May 24, 2022 by Anjali Chourasiya
Investing in the stock markets may be a great way to build wealth. As companies expand their services and offer an extensive portfolio (of products) to their customers, their earnings rise, which is reflected in their stock price. But, not every investor may have the risk appetite to enter the equity markets. Mutual funds could be a good alternative investment option for such investors to taste the equity markets with well-defined risk management.
But as an investor, what is the best way to participate in this growth mechanism- Is it through stocks or should mutual funds be preferred? What actually is the difference between stocks and mutual funds? We explore this further in the article.
Table of Contents
What are stocks?
Stocks are shares of publicly operating businesses that signify a certain percentage of ownership in the company. This also entitles the owner to participate in future earnings and profits of the business through dividends, share buybacks or reinvested earnings.
But that’s not all. The price of these stocks is heavily influenced by domestic/international market sentiments, polity decisions, changing rules and regulations and various other uncontrollable factors. The very same creates opportunities for trading and earning swift profits in the short term. They also can be great long term investment options as there is considerable risk dilution in the long term and the volatility in equity markets tend to subside over time.
Stocks: Investor profile and preferences
Stock investing is for investors who can potentially withstand the inherent volatile nature of this investment class. If you invest in stocks, your returns will depend on the company’s business model and future growth prospects that are not guaranteed to materialize. Also, the price of this investment class heavily fluctuates with various systematic and unsystematic risks.
In other words, investors need to holistically view this asset class to profit from it. In order to do this, one must possess an above-average understanding of the company’s operations, competitors, regulatory environment, industry dynamics, amongst others, while maintaining a foresight on how these parameters might change in the future. Thus, you must have a clear idea about your risk appetite before investing in stocks.
In today’s world, trading stocks is just a matter of one click. It no longer requires extraordinary paperwork or cumbersome man-hours to execute a trade. But one always needs to remember that no matter how simplified stock trading becomes, its inherent risk and volatility cannot be escaped. It is best to understand your investment personality deeply before entering the world of stocks.
What are mutual funds?
A mutual fund is a professionally managed pooled corpus invested in a variety of financial assets like stocks, bonds, etc., to generate returns for its investors. A professional fund manager manages the investments with full discretion depending on their analysis.
Mutual funds offer a way for investors to participate in the stock market without the hassles of learning about the intricacies and dynamics of stock trading. The fund manager takes on the burden of managing the investment – monitoring and analysing stocks to comprise the fund with quality names, and rebalancing was necessary to maximize profits and minimize risk. These funds considerable dilute risk because of two reasons:
- They do not concentrate the entire corpus in one asset or stock. As a result, even in turbulent times, the portfolio is balanced effectively minimizing incidents of losses.
- Experts manage mutual funds. They are professional individuals with high credentials who understand all intricacies of market functioning in and out.
Mutual funds: Investor profile and preferences
Mutual funds can be great options for investors who want to invest in stocks but do not have the time or resources to do extensive research on individual companies. Mutual funds provide an opportunity to invest in a diversified mix of assets and, as such, reduce the risk of investing in a single stock. The fund manager takes care of all the research work and makes investment decisions on behalf of investors depending on the domain, experience, and knowledge.
Mutual funds can also be the preferred investment vehicle for investors who do not wish to take too much risk. The fund manager invests in stocks to generate returns for the mutual fund investors. However, the risk exposure is lower than individual stocks because it represents a diverse basket of stocks/assets. Mutual funds are better suited for investors who want exposure to the stock market but don’t possess the risk appetite, insights, resources, or domain knowledge to carry out their research.
Stocks – Pros and cons
Pros
- The biggest advantage of investing in stocks is their potential to generate excellent returns.
- Fundamentally strong companies can help one create a long-term corpus.
- Ideal for short-term and intraday trading.
- No expense fees and continuous management (except for intraday).
- Complete control over the decision-making process.
Cons
- Stock markets are inherently volatile and hence extremely risky.
- Constant cycles and corrections.
- Extremely sensitive to all news including politics, national/international markets.
- Takes years of study to gain expertise, otherwise has higher risk and is prone to speculative trading.
- In case of market downtrends, individuals may not be well-equipped to navigate.
- Concentration in a bad stock could erode your wealth substantially if not timed correctly.
Mutual funds – Pros and cons
Pros
- Mutual Funds offer investors the benefit of diversification.
- Highly stable returns.
- Considerable risk management.
- Reduces risk exposure as opposed to investing in a single stock.
- Fund manager takes care of all the research work and investment decisions.
- No need for continuous monitoring.
- Promotes investment discipline.
Cons
- The biggest drawback of investing in mutual funds is their expense ratio which is significantly higher than buying individual stocks.
- Mutual funds also tend to have less liquidity than stocks.
- Some mutual funds have an entry or exit load that eat onto returns
- Investor only gets mutual fund units and not the possession of underlying assets
- Can only be traded at NAV price at the end of the day, unlike stocks that can be traded in real-time.
Conclusion
Mutual funds vs stocks have been a long-drawn debate in the world of investing. Investors need to understand that both mutual funds and stocks have their own set of pros and cons, which should be considered intricately before investing.
For investors who want more control over their investment decisions and have the financial resources to withstand volatility, buying individual stocks may be a better option. On the other hand, mutual funds are ideal for investors who want to invest in stocks but don’t have the time or resources to do extensive research on individual companies.
Which investment option is better for you will depend on your individual preferences and risk appetite. Do your due diligence before investing in any asset class to make an informed decision.
So, on the stock market vs mutual fund debate, which side do you fall on?
