Why Mutual Funds and Not Direct Stocks?
According to the report (till 2017 data) by Economic Times, it revealed that only about 4.5% of the total market capitalization in India is held through mutual funds. But, direct stock holding by individuals is nearly 22% of the market capitalization. This shows that the practice of directly investing in stocks is more favorable to a select group of Indians with strong purchasing power.
Choosing between the two kinds of investments depends on a person’s risk taking ability. It also depends upon return expectations and the ability to manage a share portfolio. The recent years have seen a lot of investors move from direct stocks. An increasing percentage of the average Indian population is turning towards mutual funds.
Here are a few reasons to buy mutual fund instead of stocks:-
1] Affordability –
Generally, to have a well balanced portfolio, you would need to have about 25-30 stocks in your portfolio. This can lead to a good mix of performance and stability. Such an approach can be achieved if you have a large enough corpus. As an individual, you may not have enough funds to create a adequately diversified portfolio of stocks. Mutual funds provide instant diversification. You receive diversification benefit without investing a huge corpus when you buy units of the mutual funds that are spread across several stocks.
For example, if you want to buy 1 stock of Maruti Suzuki India Ltd, you will have to spend Rs 9701 (closing as on 23rd July 2018). But if you buy a Mutual Fund which has allocation to Maruti Suzuki India Ltd stock, you can do that with for just Rs 500 as well.
2] Flexibility –
With stocks, you have to open a DEMAT and a share trading account. You have to do complex analysis on companies and sectors. This analysis has to be done to understand which stock to buy, know when to sell stocks, pay commission on each trade you make, and more. It is very convenient to invest in mutual funds. Everything gets done for you for a very small management fee. Online platforms make it even easier to invest in mutual funds. They do fund selection, annual portfolio review, automated investments and more, completely online. Exiting mutual funds at any time is very easy. Mutual fund redemption procedure is quick, simple and transparent. Switching between funds can also be done in mutual funds.
3] Transparency –
Mutual funds industry is regulated by SEBI. SEBI oversees the functioning of all the security exchanges’ in India and sees to it that there are no malpractices performed. The stocks and bonds that a mutual fund invests in are publicly available every month, so if required, you can see what your fund manager is doing. A good fund management company should make all the information on funds and their functioning, available to an investor in the form of factsheets, portfolio statements, etc. on their website.
By the instructions given by SEBI, AMC’s do the following things:-
- Transparency in purchase and sale price: – NAVs are declared and published on daily basis.
- Transparency in portfolio of fund: – AMC’s disclose their portfolio details at regular intervals and investors can view the portfolio of the fund they have invested in.
- Transparency in investor’s account: – Simple one pager account statements are sent to investor
4] Expert Fund Management –
Thorough research on companies and on the industry is required before investing in stocks. Whereas, mutual fund houses have professional fund managers along with a team of analysts to do all the research before picking the right stocks. They keep tracking them and use their skill sets to derive higher returns and mitigating the risks. Keeping watch on performance of every stock in your portfolio is not possible for every investor. Whereas, professional fund managers of mutual funds do this for you.
5] Diversification –
Mutual funds are based on the concept, “don’t put all your eggs in one basket”. This is known as diversification.
It requires good amount of money to create a good diversified stock portfolio. This limitation of stock investment is overcome by mutual funds. This is so because mutual funds receive money from public at large. This money ranges from a very small amount say Rs 500 to a large sum of a crore or more. This gives mutual funds huge power to invest in stocks across categories. This is by far the best advantage one can see of mutual fund investments.
But simply purchasing a mutual fund might not provide with adequate diversification. It’s crucial to check if the fund is sector specific or industry specific. For example, investing only in a technology and IT mutual fund might spread your money over fifty companies. But if stock prices of those stocks fall, your portfolio will suffer.