How equity investing differs from mutual fund investing
Today, if you want to invest in equities, you can either directly invest through equities or indirectly through mutual funds. Now what is mutual fund and what is equity? A mutual fund is a collective scheme which manages an equity portfolio on behalf of thousands of like-minded investors. Equity is about direct buying of stocks like Tata Steel or Infosys through your trading account and holding them in your demat account. Investing in mutual funds is less risky as there is professional management and diversification. On the other hand, investing in equity is relatively riskier as the risk is entirely on the investor.
In this debate of mutual fund vs equity, we shall at the pros and cons of investing in equity and in mutual funds. To avoid apples and oranges comparison, we shall directly compare equity with equity funds. However, we shall also look at mutual funds in a more comprehensive sense. The key difference between mutual fund and equity lies in their ability to manage risk and to facilitate financial planning as we shall see later. In this equity fund vs mutual fund and the equity vs MF debate we shall dwell at length on the equity and mutual fund differences.
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How equities and mutual fund investments are picking up
Year 2020 to year 2022 have been years of rapid growth in equity and mutual funds. Today there are more than 10.5 crore demat accounts in India, over 12 crore trading accounts on the BSE and over 14 crore mutual fund folios. SIPs alone raise close to Rs13,000 crore on a monthly basis. In short, investments in equities and mutual funds are rising at a rapid pace since the post pandemic period. It is imperative to have proper knowledge of all the investment avenues available to an individual and then make an informed choice and equities and mutual funds are the two principal options of allocating risk capital.
The debate of equity vs mutual funds is going on for a long time now and we are now seeing traction in both these asset classes. There are investors who believe in long term wealth creation through direct equities. After all, fancy stories like Wipro, Infosys and Eicher Motors are only possible in equity and not in mutual funds. But even mutual funds have been classic wealth creators if held for a longer time period. Here we look at the essential difference between equity and mutual fund investing as an approach to wealth creation. There is nothing, at the end of the day, like which is a better option, but it is about which is better for you. That is the decision that you need to take. Again, there is nothing like equity is suited to some people and mutual funds are suited to some people. In reality it is about purpose that equities and mutual funds are eventually suited to.
Differences between mutual fund and equity
To understand the essential differences between equity and mutual funds, one needs to understand the various parameters that go into this comparison. Here are some parameters on which we shall compare equities and mutual funds as asset classes.
- First and foremost, we look at the nature of ownership in the case of equities and mutual funds. In the case of equities, the shareholder is the part owner of the company. The shareholder can get dividends directly and also vote in the AGM. However, what is the status of ownership in a mutual fund? In the case of mutual funds, there is no form of ownership by the investor. They only have a share of the fund that is managed in trust or you can say they have share of the AUM of the fund. That fund itself is composed of other assets like equity and debt.
- How do they differ on the way investments are managed. The big advantage of mutual funds is that the investments are managed by professional fund managers with large support teams. In the case of equities, the buck stops with you and you have to manage risk, diversification, churn, returns, tax etc.
- Is it true that equities are riskier than mutual funds? To a large extent yes and there are two reasons for this. Firstly, the professional management of mutual funds makes it a less risky proposition. Secondly, the share of a large portfolio makes it a diversified portfolio and hence your risk as an individual is reduced. Mutual fund NAVs are less vulnerable to volatility unlike the direct equity stocks.
- Do we have to research mutual funds too. While the extent of parameters may not be as many as in equities, you still need to evaluate past returns, risk, Sharpe ratio, Treynor ratio, portfolio quality etc. Of course, research has to be a lot more rigorous in the case of direct equity investments.
- Where does the investor have a greater say in the asset mix of the investment? Obviously, investing in equities offers the investor complete freedom and discretion in decision making. The leeway is entirely to the investor to enter and exit positions as and when justified. That choice is very limited in the case of mutual funds. After all, eventually the decisions are left to the fund house and the fund management team and the investor has very little influence.
- Which of them can create multi-baggers? Clearly, for multi-baggers, you have to rely on equities, although you need to be very adept at identifying and holding on to multi baggers. For instance, stocks like Infosys, Lupin, Eicher and Havells have been true blue multi baggers over the last 20 years. But it is a lot of skill and mental conviction since multi baggers are not only about getting into the right stock but also about staying on long enough. Mutual funds can create wealth over time, but not become multi baggers like select direct equities.
- What are the parameters to consider before investing in equity and mutual fund? Here in case of mutual funds we use parameters like portfolio quality, the Sharpe and Treynor ratios (used for risk adjusted returns) and historic returns with consistency to evaluate mutual funds. In the case of equities, you look at macro factors, industry specific factors and company factors and use quantitative and qualitative factors before zeroing on equities.
- Which is more suitable for long term financial planning. Here clearly, it is mutual funds that score over equity funds. For instance, if you have a series of financial goals, then you can peg SIPs on equity funds for long term goals and SIPs on debt funds for medium term goals. This enables you to seamlessly achieve these goals since mutual fund returns are more predictable over the medium term. However, equity returns are a lot harder to predict and that is a major challenge. Hence direct equities are not too suited to medium term and long term financial planning.
- Another area where mutual funds score over direct equities is in the area of systematic investing. It is not practical for people to be investing in lumpsum all the time. People with regular income flows tend to invest in phases through the SIPs. However, that is where the difference becomes stark. One can do SIP on direct equities also, but the SIP on a wrong stock can be counterproductive. Instead, SIPs on mutual funds give the double benefit of a diversified portfolio plus rupee cost averaging.
- Finally, we come to risk versus returns versus volatility. Equities are higher on returns but also on risk and volatility compared to mutual funds. The diversified portfolio of an equity fund and the mix of other asset classes makes it automatically a de-risked proposition.
Key takeaways – which is better, direct equities or mutual funds?
On the one hand, investing in direct equities offers freedom and helps one gain a lot of insights in the respective field of investment. Also, it is the most conducive to create multi-baggers in the long run. On the other hand, investing in Mutual Funds is the best catalyst to help you achieve your long-term goals. The mutual fund investment is an automatically risk reduction strategy since fund management is handed over to a seasoned professional and the large corpus enables diversification of the portfolio.
At the end of the day it depends on the situation and the problem statement that you want to address. For a long term financial plan and for meeting financial goals, mutual funds are an automatic fit as an asset class. Direct equities are best for long term multi-baggers to give that added boost to your wealth. Ideally mix with a predominance of mutual funds in your portfolio and a small portion allocated to direct equities for that added panache to your wealth.