Investment in stocks or mutual funds?

Any study of different Asset Classes as an investment option, clearly shows that, in terms of returns, Equity beats all other asset classes by a clear margin.

If you look at other parameters like convenience, holding cost, taxation, nomination etc, still Equity in its digital format, beats all other asset classes, on all these parameters also.

Why is it then that Equity always has very diverse reactions? 

Whenever you mention the magic words, “ Equity investing”, you get extreme reactions. There will be investors who will have a story, about how they have lost a fortune in the last crash and there will be others, a minority though, who have gained tremendously with stories about how the Reliance stock took care of his daughter’s wedding or the initial allotment of Infosys helped him buy a house.

The moment you mention the magic words, suddenly the investor starts expecting overnight fortune and magic returns. Expectations are that money will double or triple in the immediate future. People treat Equity as a lottery.

(Check out our previous blog, https://sahayakgurukul.blogspot.com/2018/10/why-dont-investors-make-money.html)

The next question thus, which arises is to assess the risk and return quotient of Equity, the probability of loss when you invest in Equity. Studies show that due to inherent volatility of equity as an asset class, the probability of loss can be more than 30% in first few years. This reduces considerably as the years go along and becomes zero by year 10. In case of Equity Mutual Funds, the probability of loss is zero after only 5 years. Hence anyone with a horizon of more than 5 years will generally not lose money after 5 years.

Now that you are convinced, that most of your long-term money must be invested in equity, the question to be tackled is how should you do this. 

There are two distinct ways of investing in equity. One is to choose stocks and the other is to invest through equity mutual funds. 

Over the years, we have reviewed various stock and mutual fund portfolios. 

In both the cases, the returns have virtually been in the same range. You can expect 13-16% CAGR in quality Equity Mutual funds over a 10 year period, though there also have been more than 20 funds which have grown by more than 25 times in the last 15 years. 

In Stock Investing also, the portfolio return in a stock portfolio of around 20 quality stocks have generally delivered a lower return. This is because, out of the 20 stocks, around 8-10 stocks will give you an above average return, some will give an average return and others will give a negative return and turn to be duds, thus leading to an average return overall.

Direct stock Equity Investing is serious business. It involves your hard earned money. Unless you have developed the expertise and fully understand the dynamics of the stock market and individual companies, and are able to put in considerable time and effort, you should not invest in equities directly. To optimize gains from the stock market, you have to adopt direct stock investing as a full time activity not as a part time indulgence. Therefore, for every beginner at least, the choice is quite straightforward; you must invest through mutual funds.

In this age of frequent disruptions caused by technology and other factors, individual stock picking can be quite a task. With 150 changes in the past 18 years, the 50-share Nifty is very different from the index that was launched in 1996. Only 16, or 32 per cent, of the original 50 constituents are still in the index. Of these, only 13 have stayed throughout. Thus the Blue Chips at one stage no longer figure in the list after a while. So the era of Buy & hold a stock also is no longer valid. Stock picking and churning of stocks is best left to professional fund managers, who have access to the latest trends, analysis and research tools. 

There are many advantages to investing in equity through mutual funds. A major one is a disciplined diversification. Fund managers operate within an institutional framework, as outlined by SEBI, which enforces certain ground rules of investing. This ensures that the portfolio stays diversified and safe from shocks that may strike individual stocks, sectors or different category of stocks. Individuals who manage their own stock investing would rarely have the knowledge or the discipline to do all this.

Being able to start investing in small and flexible amounts, which can be as less as Rs 500, is another big advantage. If you try to build a diversified portfolio with stocks by buying them directly, you'll need a relatively large sum of money. In mutual funds, you can start off by owning the same with a few thousand rupees. You can invest regularly and automatically through a SIP with a certain amount every month. You can also save tax under section 80C by investing up to Rs 1.5 lakh a year in ELSS category of equity mutual funds.

The above factors make it quite clear that Equity Mutual funds is a better alternative to stocks, of investing in Equity, to maximize your investment returns.

Our sincere advice is that you should consult a credible financial advisor for all your investment needs. He can help you plan your financial goals and the most optimum route to achieving the goals. Check out our earlier blog on the subject, https://sahayakgurukul.blogspot.com/2018/10/do-you-need-investment-advisor-guru.html.

Happy Investing!

Stay Blessed Forever,

Sandeep Sahni