Who offers better returns? Direct stock investment or mutual funds?

    The way Indian investors save is changing day after day. The trend now is slowly shifting with more and more opting out of traditional fixed income schemes like Bank fixed deposits, Public Provident Fund, Post Office Savings Scheme, etc. Although this is good in a way considering the low interest rates on offer (5% to 7%), retail investors are having a tough time determining whether they should switch to direct stock investment or mutual funds.

    The primary reason why it makes sense to invest in mutual funds and stocks is because they have the potential to offer inflation-beating returns. But investors are often confused in deciding which investment avenue to choose between the two. Both mutual funds and direct stocks carry a high investment risk and investors are expected to determine their appetite for risk before making an investment decision.

    What is a mutual fund?

    A mutual fund is an investment product that pool financial resources from investors and invests the capital raised to achieve a common investment objective. A mutual fund invests in a diversified portfolio of securities across asset classes and money market instruments. The performance of a mutual fund scheme is highly related to the performance of all its underlying securities.

    What is direct stock investment?

    A direct stock investment takes place when an investor buys shares of a publicly listed company during live trading hours at the stock exchange. When an investor purchase shares of a company, he becomes the shareholder of the company.

    Understanding the major differences between stocks and mutual funds

    If you are new to investing, it is important to understand that direct stock investment is much riskier than mutual fund investment. Mutual funds invest across asset classes and fixed income securities and have a diversified underlying portfolio. This is not the case with direct stock investment because when you buy shares of a particular company you are only investing in that particular stock. Investing in stocks require extensive research whereas even a novice can invest in mutual funds and give themselves a chance to earn capital appreciation. Mutual funds offer active risk management as they have designated fund managers who are responsible for trading securities daily to help the scheme achieve its investment objective. With direct stock investment, investors are solely responsible for maintaining the hygiene of their portfolio and have to trade their shares to earn profit. However, mutual fund houses do not offer active risk management at free of cost. Investors have to pay annual management fee in the form of expense ratio which is levied on every mutual fund scheme.

    Who offers better returns? Mutual funds or direct stock investment?

    Mutual funds have the potential to offer far better risk adjusted returns as compared to stocks. That is because one single unit of a mutual fund scheme is a combination of multiple stocks. So, even if one asset class or underlying stock of a mutual fund fumbles, investments made in the other asset classes even out the losses. When it comes to direct stock investment, if the company whose stock you bought fumbles, the value of your shares will go down as well. Stocks are highly sensitive to market vagaries which is why a slight change in the market has a direct impact on its performance.

    To earn long term capital appreciation, it is essential to diversify your investment portfolio. Stocks do not diversification whereas mutual funds do. Mutual funds offer active risk management, stock investment does not. With stocks, investors have control over their investment but with mutual funds investors can only buy units as the fund managers decide which stocks to buy or sell.

    Before investing your hard earned money in either of the investment avenues, please understand your investment objective and invest according to your goals.