Shares are the physical representation of a small portion of a company’s value that are traded in the stock market. When a company goes public and issues shares, the combined value of the shares of the company in the stock market and/or owned by persons, constitutes the total value of the company. Being a shareholder is in effect owning a small part of the company and means that one can take part in the annual shareholder meets.
Mutual funds are a collection of stocks and bonds that are managed by fund managers in an Asset Management Company (AMC). If it is an equity mutual fund, it will contain stocks, while debt mutual funds will contain government bonds and securities. A mutual fund is like a huge basket with shares from several companies. For example, DSP BlackRock Micro Cap Fund consists of stocks of 62 companies from diverse sectors, including Finolex Cables, DCB Bank, Manappuram Finance, Somany Ceramics, JK Lakshmi Cement, Siyaram Silk Mills, Ashiana Housing and Sun Pharma.
Investment in mutual funds are a form of investment in stocks and bonds that is managed by an AMC or investment house, while direct investment in stocks and shares is an active form of investment, where you are handling the purchase and sale of the products yourself. The institutionalisation offered by mutual funds is good for a new investor, while direct investment in shares is good for those who know the market and can handle it themselves.
Difference between Investment in Mutual Funds and Direct Investment in Stocks
The following are the key differences between investment in mutual funds and shares:
- Shares are a part of a business’s growth strategy, while mutual funds are investment options for individuals.
- Trading in shares requires you to have a demat account. Mutual funds do not need a demat account, though if you have one, you can use it to handle mutual funds.
- Mutual funds being a portfolio of stocks of companies pre-determined and altered by a fund manager, you as an investor have no control over the actual choice or trade of stocks. You also cannot choose to exit from 1 or 2 of the stocks from the portfolio.
- Mutual funds are managed by a fund manager in an AMC. This external management of portfolio ensures that there is direct involvement on the part of the investor except at the time of choosing the fund. For this reason, mutual funds are ideal for a new investor who does not know much about the stock market. Direct investment in shares, on the other hand, requires strong knowledge of the stock market and company performances. It is a hands-on activity involving quick market decisions and is better for experienced stock traders.
- The passive nature of mutual funds makes it easier for anyone and everyone with money to take part in it. For direct investment, you need more time and dedication.
- You can invest in mutual funds through a fixed monthly Systematic Investment Plan (SIP), as it is managed by a professional. You cannot make such a fixed investment in shares directly as the prices fluctuate constantly and need personal attention and prompt trade decision.
- Because mutual funds hold a diversified portfolio, negative returns are cushioned by the other stocks that do well. For example, if your portfolio contains 35 stocks, of which 3 are dropping, even the slightest growth in the other 32 will prevent your overall fund value from coming down. Direct investment in stocks does not offer you this protection and makes your stocks volatile. Unless you are dealing in a significant number of stocks at the same time, your money will be at high risk.
- Mutual funds have a longer-term growth trajectory and will give good returns only after 5-7 years, while shares could give you quick returns if you buy and sell at the right time and choose high-growth stocks.
- In mutual funds, you need to pay fund management charges, a front-end load upon initial purchase, back-end load upon sale, early redemption charges, etc. In direct investment in shares you need to pay brokerage to the stock broker.
- It is easier to diversify your portfolio using mutual funds – there are options such as hybrid funds. While dealing with shares, you may not be able to juggle with a large portfolio yourself.
- Direct investment in shares can give you tax benefits only under Section 80CCG, while tax benefits on mutual funds can be claimed under Section 80CCG as well as 80C if it is an Equity-Linked Savings Scheme (ELSS).
Whether you must invest in mutual funds or shares depends on your knowledge and experience of the market and the amount of time you have. Mutual funds are a great investing instrument if you are a dilettante and aim for a steady growth of wealth. But if you are a stock market virtuoso and have enough time in hand, direct investment in shares is a better choice.
GST rate of 18% applicable for all financial services effective July 1, 2017.