What are the benefits of investing in mutual funds versus directly in shares
As mutual funds invest in stock, some investors feel that they may be better off investing directly in stocks through a stock broker instead of investing in mutual funds. Some investors cite fund expense ratios, lack of control over the investments and commission to mutual fund distributor as key reasons why investing directly in stocks may score over mutual funds.
However, according to us, mutual fund is a better if not the best investment option for retail investors in India, since the benefits of investing in mutual funds far outweigh the costs and other considerations.
Let us see what are the key benefits of investing in mutual funds versus directly in shares? But before that let us know what are mutual funds in India?
What are mutual funds in India?
In short, mutual fund is an investment instrument which pools the money of different people and invests them in different financial securities like stocks, bonds, gold etc. Each investor in a mutual fund scheme owns units of the scheme, which represents his or her portion of the holdings in the said scheme. The securities selected for investing are in line with the investment objective of the scheme. Mutual funds are managed by asset management companies (AMCs) which appoints fund managers to manage the different mutual fund schemes and ensures that the scheme investment objectives are met.
For fund management and other services provided by the AMC, it charges a fee, known as expense ratio to the investors. These expenses are charged against proportionately against the assets of the fund and are adjusted in the price of the unit. Therefore, the NAVs that you see for a mutual fund scheme is post adjustment of the expense ratio.
Would you like to know how asset management companies work in India
Let us now discuss the major advantages of investing in mutual funds versus directly in stocks.
- Diversification of risk: The biggest advantage of investing in mutual funds versus stocks is the risk diversification. Mostly investing in stock is subject to three types of risk – company risk, sector risk and market risk. While the company and sector risk are known as unsystematic risk, the market risk is known as systematic risk. What is the essential difference between unsystematic and systematic risk?
The stock price of a company may fall if the company’s financial performance is poor, even if the market rises. On the other hand, even if the company performs well, the stock price may still fall, if the market falls.Mutual funds help investors diversify unsystematic risks by investing in a diversified portfolio of stocks of different sectors. Hence mutual fund investing risk is much lower than the risk of investing in individual stocks.
Read what are diversified equity mutual funds
- Smaller capital requirement: Investors require a large capital to build a portfolio of stocks. But, on the other hand, as mutual funds work on the basis of pooling of money from different investors, investors can have the beneficial ownership of a diversified portfolio of stocks through mutual funds with a much smaller investment. Investors can buy units of a diversified equity mutual fund scheme with an investment of as low as Rs 500 – Rs 1,000/- only (it is Rs 500 minimum if you are investing in an ELSS mutual fund scheme)
- Investment expertise of the fund managers: Choosing the right stock or investing in the market requires a lot of expertise along with experience. Many retail investors lose a lot of money in share trading because they do not have the adequate expertise. Mutual funds, on the other hand, are managed by professional fund managers who have sufficient expertise and experience in picking the right stocks to get the best risk adjusted returns.
- Lowe transaction costs: Since mutual funds buy and sell securities in large volumes transaction costs on a per unit basis is much lower than what retail investors may incur if they directly buy or sell shares through their stock broker.
- Range of products: Mutual funds offer a variety of products suiting the risk profiles and investment objectives of investors. In fact mutual funds have products which to meet investment needs of one day to life time. Apart from equity mutual funds which are very popular with investors, there are also balanced funds which help moderate risk takers and retired people to earn a regular income, monthly income plans if you have monthly income needs,income funds and liquid funds to suit different investment requirements of short term and medium term.
Know more about different types of mutual funds in India
- Many modes of investments: Mutual funds also offer investors many ways of investing and managing their investments. One can opt for different investment modes like lump sum,systematic investment plans (SIPs), systematic transfer plans (STP) and systematic withdrawal plans (SWP), switching facility from one scheme to another and profit booking facility by way of switch and redemption etc. You can even invest in dividend payment option of a mutual fund scheme if you want income from your investment. No other investment products, other than mutual funds offer such wide array of investment modes.
Read what is SIP and its benefits and what is STP
- Disciplined investing: Share prices are highly volatile and thus induce the investors to buy or sell in short time periods due to fear or greed. Frequent stock trading often leads to making losses in the market. Mutual funds encourage investors to invest over a long time horizon, with an investment objective or goal in mind.ThroughSIPs or systematic investment plans,mutual funds encourage investors to invest in a disciplined manner to meet their long term financial objectives like retirement, children education and marriage.
On the other hand, most of the investors fail to build a substantial investment corpus because they are not able to invest in a disciplined way through stock trading. Usually stock traders very often get enthusiastic in bull markets, but get nervous during bear markets.
Therefore, by investing through SIPs in a disciplined, though mechanical way, investors can build sustainable investments which are critical to achieving their financial objectives.
We have discussed how the benefits of investing in mutual funds score over investing directly in shares. Even though investing directly in shares may give you a sense of greater control, the benefits of investing in mutual funds outweigh that of investing directly in shares for the various reasons we mentioned above.For retail investors, therefore, investing in mutual fund definitely makes a better sense over investing in stocks.