Investments may it be in direct equities or mutual funds requires a lot of time and energy. Each approach has its own advantages and disadvantages. Direct equity investing is considered more dynamic by the investor community and thus, those who can keep a continuous tab on the equity markets prefer the direct equity route as it gives them much needed zing and excitement. However, the dynamism in the direct equity investment comes with risk. Hence, only those investors who are able to understand the nitty-gritty of the equity markets and who are able to devote time and energy can adopt this route to equity investments.
But not all investors are same in their intelligence and understanding levels. And even if someone has the ability to understand the direct equity route, he or she lacks the time to devote to such investment activity and thus prefer taking the indirect route to equity investments which is mutual funds.Mutual funds provide the much needed ease while investing in the equity asset class. Here are some of the advantages which mutual funds’ provides its investors’ vis-à-vis the direct route to equity investments:
Investing in stocks directly has one serious drawback - lack of diversification. By putting all money in just a few stocks, the investor subjects himself to considerable risk should even one of those stocks decline.
On the other hand, a mutual fund scheme by investing in several stocks tries to overcome the risk of investing in just 3-4 stocks. By holding say 20 to 30 stocks, the fund avoids the danger that one rotten apple will spoil the whole portfolio. Mutual fund schemes own a couple of dozen to more than a hundred stocks in their portfolio. A diversified portfolio can generally hold its downside even if a few stocks fall dramatically. This helps in containing the overall risks.
Outperforming the indices (Source: ACE MF, PersonalFN Research)
- Professional management
No matter how sound an investment sense a stock investor may have, sooner than later he will realize that active portfolio management requires considerably more skill, not to mention a lot of time too. There is an ocean of a difference between part-time stock-picking and full-time fund management.
Now compare this to mutual fund investing; the mutual fund investor does not have to track the prospects and potential of companies in the portfolio. Mutual funds are managed by skilled professionals who continuously monitor these companies and take decisions on whether to buy, sell or hold a particular stock in the portfolio.
- Lower entry level
There are few quality stocks today an investor can enter into, with just Rs 3,000 – Rs 5,000. Investing in stocks can be an expensive affair. Sometimes with as much as Rs 5,000 an investor can buy just a single stock.
The minimum investment in a mutual fund may be as low as Rs 500. This implies that with just Rs 500, a mutual fund investor can take exposure in a fund portfolio of 20-30 stocks. The entry barrier in mutual funds is low so as to encourage investor participation.
- Economies of scale
By buying a handful of stocks the stock investor loses out on economies of scale. This tends to pull down the profitability of the portfolio. If the investor buys/sells actively, the impact on profitability would be that much higher due to the various charges involved.
Due to frequent purchases/sales, mutual funds incur proportionately lower trading costs than individuals. Lower costs translate into significantly better investment performance and returns to the investors.
- Innovative plans for unit-holders
By investing in the stock market directly, the investor deprives himself of various innovative plans that are offered by fund houses. Fund houses offer automatic re-investment plans; systematic investment plans (SIPs), systematic withdrawal plans, asset allocation plans, triggers, etc. These features allow investors to enter/exit or switch from funds seamlessly and on the whole facilitate investment ease significantly. This is something the investor can never duplicate individually.
A stock investor may not always find the liquidity in a stock to his liking. There could be days when the stock is hitting the up / down circuit and buying/selling is curtailed. This does not allow him to enter / exit a stock.
Such liquidity problems are not confronted by a mutual fund investor. Sometimes a mutual fund may be more liquid than other investment avenues. For instance, there are days when there are no buyers or sellers for an individual stock. But an open-ended fund can be bought / sold at that day's NAV by simply approaching the fund house or its registrar or a distributor.
- Minimises loss
Investing in mutual funds assures more safety of investment than investing directly in stocks. A company may shut shop or may go bankrupt and according to the law, the equity shareholders are paid last, after paying all dues to the creditors of the company.
A mutual fund may lose money, but may not go down as easily as a company. The legal structure and stringent regulations that bind a mutual fund safeguard a unit-holder's interests far better. As highlighted above, investing in mutual funds has some unique benefits that the direct stock investor would find it difficult to duplicate. By no means are we are stating that mutual fund investing is a sure-shot way of logging growth. This can be done even by investing directly in stocks. However, mutual funds offer the investor a relatively safer and surer way of picking growth minus the hassle and stress that has become synonymous with stocks over the years.
Investors should also keep in mind that selecting a mutual fund scheme is not alike buying vegetables from a grocery story . A thorough analysis is required to select winning mutual funds for one’s portfolio in order to create wealth over the long term.