Mutual Funds vs Stocks: What’s the Difference?
What is the difference between investing in a mutual fund vs investing directly in stocks? This is a question we are often asked. Well, there are quite a few!
Stocks and mutual funds are very different financial investment tools; they have different returns, risks, and are used for different purposes. The way you spend, as well as the strategies and taxes that follow, are all different. However, soon enough we will find which is a better option.
Investing in Mutual Funds vs Stocks?
When you buy stock of a company and invest directly in it, you are basically being a part-owner of the company. Any share of the business means owning a stake in the company. This may include voting privileges, a dividend (a portion of the company’s profits), and participation in the company’s Annual General Meetings. But that’s depending on the company’s bylaws.
Basically, investing in the stock market pays off for investors in two ways:
- the stock price rises, and
- the dividends they earn per share they buy.
Investing in a mutual fund, on the other hand, is a little different. You are entrusting your funds to a fund manager, who will pool your funds with those of other investors to purchase various financial securities (such as stocks or bonds). The businesses in which the fund invests do not make you a part-owner (the mutual fund takes on those rights). The profits you earn will come from either the selling of your mutual fund units or the dividends paid out by the mutual fund (if the mutual fund chooses to do so).
Try to think of this way: if you borrowed money from a friend and invested it in stocks, you, not your friend, will be a part-owner of the business. Similarly, mutual funds claim ownership and voting rights of your assets, even if it is your money they are investing in.
As a result, you can end up indirectly investing in stocks through a mutual fund. Learn about mutual funds and how to invest in them.
Distinction Dividends from Mutual Funds and Stocks
When it comes to dividends, mutual funds have two options. First, the mutual fund shares the dividends it earns from its options as a dividend option. The second option is the growth alternative where the mutual fund reinvests dividends back into investments.
On the flipside, when you invest in stocks directly, your investment is determined by your intuition, analysis, and experience. For a mutual fund, a team of analysts and managers conducts extensive research to determine the best investments and when to rebalance.
Now that you know the difference between mutual funds and stock market investments, you can make more rational decisions. Let’s compare the characteristics of stocks and mutual funds to see which is the best choice for you.
Which is the Best Choice?
Diversification is the real key to a successful portfolio! When investing directly in stocks, make sure your portfolio is well-diversified across markets. And for the most part, managers of mutual funds do this for you. This is because they want their funds to be well diversified in order to maximize returns.
If you’re new to the stock market, you don’t know how well you’ll do because you don’t have any previous results to compare to. You can review a mutual fund’s annual returns to see if they have met your goals.
Mutual Fund vs Stock Investments: How they Work
The following are some main distinctions between a mutual fund and a direct stock investment:
The Return on Investment
In general, it’s way riskier when investing directly in the stock market vs. investing in mutual funds.
This is why most individual’s retirement plans depend heavily on mutual funds. Although, investing in a single stock carries a high risk and high reward potential. Equity mutual funds hedge and ensure that negative returns on certain stocks are offset by high returns on other stocks by diversification and awareness.
Management and Experience
It would be difficult to compete with mutual fund management unless you are a well-trained, competent, and seasoned investor. Mutual funds are staffed by people who do research, have extensive expertise, and years of cumulative experience. Furthermore, they would be less prone to prejudice, as many individual investors rely on reasoning such as “I’ve heard great things about this business, so I should buy its stock.” Mutual funds conduct extensive analysis and due diligence on a scale that an individual investor cannot.
Expanding the horizons
You’ll need at least 20 stocks, all weighted evenly, to build a well-diversified portfolio. You’ll have to rebalance these stocks on a regular basis to maintain diversification and ensure that one or two stocks don’t alter the composition of your portfolio’s holdings. Direct stock investment on the other hand, is both costly and time-consuming; you won’t be able to create a diversified portfolio with $1,000. Mutual funds, on the other hand, would take your $1,000 and send you a unit in a mutual fund that represents a well-diversified portfolio.
Trading Hours
You can buy stocks directly during trading hours (9:15 a.m. to 3:30 p.m.), and you can do so many times per day. You can only buy or sell units in mutual funds once a day, at the end of the day, when the NAV is decided.
Tax Advantages
According to reports, tax exemptions of up to 5% are available if you invest in ELSS mutual funds. Investing in securities directly would not have any tax advantages.
Why Are Mutual Funds Better?
At this point, it should already feel like I am endorsing investing mutual funds over investing in stocks. Well, that’s because the advantages are excessive. The pros obviously outweigh the con. I’m not trying to write off stocks, but there are two kinds of investors, the risk-takers and the risk-averse investors. Stocks work fine for the former and mutual funds for the latter.
But ever wondered why everyone’s always talking about mutual funds? Here’s why…
Management Expertise
A mutual fund’s portfolio and assets are managed by trained managers who devote their entire time to evaluating, monitoring, and managing them. This is the fund’s responsibility. It would be difficult to have both this experience, and the time, and commitment to do this unless you are a full-time investor.
There are no taxes on gains made in the short term
If a stock has skyrocketed in value and you want to profit from it, within the first year, you’ll need to pay a 15% Short Term Capital Gains (STCG) levy. However, if a mutual fund has invested in it, they will not be taxed, so their profits will be 100 percent (not 85 percent due to you paying the tax). As a mutual fund unitholder, this will favor you.
Investing Is Easier
A Demat account is not required to invest in mutual funds. More importantly, NRIs don’t even need a PIS account; they can use their NRO account instead!
Is It Better to Invest in Stocks or Mutual Funds?
A mutual fund provides diversity by investing in a variety of stocks. Owning shares in a mutual fund is preferable than owning a single stock since an individual stock involves more risk than a mutual fund. This is referred to as unsystematic risk.
Are Mutual Funds More Safer Than Stocks?
Mutual funds are less risky than individual stocks because they are more diversified – that is, they include a variety of investments.
Why Do People Invest in Mutual Funds Rather Than Stocks?
When you buy a stock, you are buying a piece of one corporation. A mutual fund provides more diversification by combining multiple firm equities into a single investment.
What Are Disadvantages of Mutual Funds?
High expense ratios and sales charges, managerial abuses, tax inefficiencies, and poor trade execution are all disadvantages.
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