Stocks are riskier until and unless you choose quality stocks. But when you focus on returns, stocks promise higher returns than mutual funds. You can earn annual returns on equity of 15 – 20% whereas mutual funds offer 8 – 12% returns.
Investing in mutual funds or stocks mainly depends on four factors.
- What’s your risk profile?
- How much return you need.
- How much time you have/willing to spend on research work.
- What type of fees and taxes you are ready to bear.
Let’s understand each factor in detail.
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Risk Reward Ratio
Here two factors are interrelated – how much risk you can tolerate and how much return you want or need. Consider your emotional tolerance associated with risk and your financial state to determine a risk/reward ratio for you. However, limiting your risk ultimately results in limiting returns from your investment. To earn a higher return, accept a higher degree of risk.
If you want to limit your risks, diversify your investments. Here come mutual funds that diversify investments. It may have a mix of stocks and bonds or 100% stocks of different companies.
Bonds are less riskier than stocks, so mixing them with stocks in a portfolio helps to reduce risk. And all stocks are not of a single company. In case, a single company gets lower in value, another company’s stock can balance it out.
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Time Frame
Each type of investment requires research. People who are taking investing and trading as a full-time job can go for direct equities because the investing success rate depends on how much time you can spend to research financial statements. You need to investigate several companies to find the best ones. Or say how much you enjoy researching how much money a company is making, from where the income comes, the economic impact on a company, its total worth, and what’s the company planning to increase income. Otherwise, mutual funds are the options.
Mutual funds also need research by investors but not that much. You need to find out what type of mutual fund you want to invest i.e. which type of stocks, which index fund, which sector, which target-date fund, etc. That’s it. Individual research will be done by fund managers.
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Cost and Fee
Stock investing avoids extra costs and fees, unlike mutual funds. The only fees you need to pay a brokerage to trade orders. Demat account opening fee varies from broker to broker. There are other Demat account charges in addition to the account opening charges such as AMC, off-market transfer charges, pledge charges, etc.
Mutual funds are managed by fund managers and they charge quite high fees. Such fees may vary for different types of funds. Fee for some funds is applicable when you buy the fund, while others at the time of selling the fund. To buy some funds, you require at least a minimum investment amount that’s the reason to create cost-related barriers. Capital gains taxes to sell the funds are also included in the mutual fund’s costs.
The Bottom Line
As a beginner, avoid investing in equities directly. While every investor’s situation is different, you can use the above-mentioned guide to make investment decisions. If you are ready to pay some extra costs for the convenience of minimizing your risk and research time, then mutual funds are for you. And if you enjoy deep digging into financial research with a high-risk profile, then stock investing is for you. However, you can utilize both instruments for different goals to meet various long-term goals.
