SHARES OR MUTUAL FUNDS? WHICH IS A BETTER INVESTMENT VEHICLE FOR COMMON PEOPLE?
“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go”
–Benjamin Graham, the British-born American Economist known as “the father of value investing.”
As the above saying goes, one should have a financial plan in place that is tailored to his/her needs and financial goals. Not everyone will have similar financial goals – for some investing in financial instruments may be the primary source of income; for some it may be a secondary source of income; for some the goal may be long term investment such as wealth building; for some it may be a short-term investment goal; for some it may be having a corpus for the post-retirement life; for some it may be an investment for children’s education and marriage; for some it may be a backup fund for the rainy day and so on and so forth.
Also Read: How to Manage Your Finances in a Systemic Way
The most common question that comes to the mind of a novice investor is whether he/she should invest in shares or in mutual funds? The answer to this is not that straightforward. Several factors influence one’s decision to choose a particular investment vehicle – be it shares or mutual funds.
To begin with, a brief heads up on what are shares and mutual funds?
Shares: Shares are financial instruments issued by companies or corporates to raise funds from the general public. A share is the smallest unit of the company’s overall net worth. The holders of these shares are called shareholders and they are part owners of the company. The extent of ownership of a shareholder in the company depends upon their holdings in the company.
Dividend is the return on investment of the amount invested by the shareholder. Dividends are paid to the ordinary shareholders after the company pays taxes, interest and dividends to the preference shareholders. Dividends are usually paid from the profits made by the company. They may be paid quarterly, half yearly or annually. The equity shareholders undertake the highest risk and hence the returns are also high for them.
Mutual funds: According to the Association of Mutual Funds in India, mutual fund is a pool of money managed by a trust that collects money from a number of investors sharing similar investment objectives and invests the same in equities, bonds, money market instruments, and/or other securities.
Mutual funds are the most popular investment vehicles and suitable for investors whose investment amount is small or for those who neither have the inclination or the time to research the market, yet want to grow their wealth. Professional fund managers manage the money collected from the investors in line with the scheme’s stated objective. In return, the investors are charged a small fee by the fund house, which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by the Securities and Exchange Board of India (SEBI).
Mutual funds offer multiple product choices for investment across the financial spectrum. The Indian mutual fund industry offers a wide choice of schemes and caters to all types of investor needs.
Read also: A Beginners Guide to Systematic Investment Plan
COMPARISON BETWEEN SHARES AND MUTUAL FUNDS
|Shares are a suitable investment option for investors who have knowledge about the markets and have the time to do extensive market research before investing.||Mutual funds are managed by professional fund managers who take care of investments after extensive market research. Hence, these are the most suitable investment option for a common man who lacks knowledge to invest in securities markets.|
|Shares generate higher returns and the profitability of the investment depends almost entirely on fluctuations in stock prices, which are basically linked to the growth and profitability of the company.||Mutual funds generate less returns when compared to stocks.|
|Shares also hold higher risks since the share prices tend to fluctuate which are fundamentally tied to the profitability and growth of the company. There have been cases where there has been drastic reduction in the value of investments.||Mutual funds hold lower risks when compared to stocks due to the diversified portfolio that they invest in. Due to this, when a particular company’s share price hits rock bottom in the market, the mutual fund investor will not be hit as hard as an investor who owns only that particular company stock.|
|Benefits of rapid growth are high in shares.||Benefits of rapid growth are less when compared to shares.|
|Shares offer diversification only in their portfolio, in the sense, one can buy shares of companies belonging to different sectors such as banking, oil and natural gas, pharmaceuticals, etc. There is no diversification with respect to the kind of financial instruments one can invest in such as bonds, equity, etc.||Mutual funds offer a wide array of schemes which one can invest depending on one’s financial goals and requirements. These investments are hybrid in nature. They invest in stock market, bond market, money market instruments such as Treasury Bills, Certificate of Deposit, etc., which may not be available to retail investors.|
Now, the big question is which is the most suitable option for a common man – shares or mutual funds?
Considering that an overview of both shares and mutual funds has been given above, you may have gained a fair idea about both. But again, several factors influence one’s investment decision:
- Individual’s financial goals – whether the goal is primary source of income, additional source of income, long term investment for purposes like child’s education, marriage, retirement, etc. or wealth building. Having a clear-cut goal will help one to make a proper decision. If you do not have any other source of income and would like to invest in markets to earn a steady income, then mutual funds are the right choice. There are mutual funds which offer SWPs (Systemic Withdrawal Plan), which allows you to withdraw a fixed amount from your mutual fund at regular periodic intervals. They could be monthly, quarterly, half yearly or annually. This option is suitable for people in the post-retirement stage.
- Ability to tolerate risk – By considering both your emotional tolerance for risk as well as your financial situation, you can determine a risk/reward ratio that works best for you. If you are ready to take higher risk, then shares are the appropriate option. If you have low risk tolerance, then you may go for mutual funds that offer growth and dividend reinvestment options.
- Duration of investment– If you are looking for long-term investment where you can afford to lock your funds for a longer period, then you may go for mutual funds.
- Knowledge about securities market: If you have good knowledge about securities market such as market behavior, performance of different companies, etc., then you may try investing in shares.
- Time availability– Do you have enough time at your disposal to research the markets and keep a tab on the market performance? Then, you are the right person to invest in shares. But, if you don’t have the time or patience to study the markets, then you may go for mutual fund investment as mutual funds are managed by expert Fund managers who will manage the show for you. You just need to spend very less time to figure out what type of fund you need, whether it’s an index fund, Exchange Traded Fund (ETF), etc. You should also look at the historical performance of a mutual fund and compare it to similar funds that track the same benchmark. Once, this research is done, you can leave the rest to the Fund Manager.
- Costs and fees – If you would like to avoid extra costs and fees, then shares are the right option for you. You may have to incur a minimum brokerage fee alone. But in the case of mutual funds, some funds charge an entry fee, some charge when you sell the fund and some funds charge management fees to pay the fund managers. If your primary aim is to invest without having to spend time on doing research and for that you don’t mind incurring a fee for fund management, then you may go for mutual funds without much thought.
- Size of investment: If the size of investment is very small, say, from Rs. 1000 – 5000, then you can go for shares as they don’t have any minimum amount for investment. But, in the case of mutual funds, some funds require a minimum investment quantity.
- How to Manage Your Finances in a Systemic Way
- EQUITY MUTUAL FUNDS AND 12 TYPES OF EQUITY MUTUAL FUNDS
Everyone’s needs and financial goals are different. But, there are some general guidelines that you can use to guide your investment decisions. If you are a person who is an amateur to financial investments, has less time for research and averse to risk, but willing to take on some extra costs and fees for that convenience, then mutual funds may be a better investment choice. But keep in mind that in order to reap maximum benefits from mutual fund investments, one has to diversify his investment across different categories of funds such as equity, debt and gold.
On the other hand, if you have the financial acumen and knowledge, enjoy deep diving into financial research, taking on risk, keen on earning high returns and would like to avoid fund management fees, then investing in shares may be a more suitable option.
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