Do you want to build wealth but do not know how? Well, investing in financial instruments is one of the effective ways to accumulate assets. There are many options available with financial products, thus, choosing the right one can often feel overwhelming. Stocks and mutual funds are the two most popular avenues, each having its pros and cons. While Mutual funds offer diversification of funds with lower risk, stock is a high-risk, high-return choice. Deciding which could be better depends on your financial goals and risk tolerance.
In this article, we will detail mutual funds vs. stocks, analysing their respective pros and cons for different types of investors. So, without any further delay, let’s dive in!
What are Mutual Funds?
Mutual funds are one of the best investment options that pool money from various investors to invest in different asset classes such as stocks, bonds, commodities like gold, and money market instruments.
This is an effective way for investors who want to diversify their risk and achieve their financial goals successfully. Moreover, mutual funds are managed by portfolio managers who make investment decisions on behalf of the owner.
What are Stocks?
Stocks, also known as shares, give an investor ownership in a publicly traded company. These shares entitle investors to take proportionate claims in the assets and profits of an organisation.
There are two types of stocks, namely common and preferred shares. Common stockholders have voting rights and receive dividends. Preferred stockholders typically receive fixed dividends but have limited voting rights.
Share price is determined by supply and demand forces in the stock market. Anyone can buy and sell shares on a stock exchange or through the over-the-counter market.
Difference: Mutual Funds vs. Stocks
| Objective | Mutual funds | Stocks |
| Definition | Mutual funds are collected from multiple investors, and the money is invested in a diversified portfolio. | In stocks, ownership in the company is given to the shareholders. The company’s capital is divided into shares that can be bought or sold on the stock exchange. |
| Management | Mutual funds portfolio is managed by professional fund managers. | Investors have to manage their stock portfolio by themselves when they invest directly in shares. |
| Diversification | With mutual funds, an investment portfolio diversifies across various stocks and sectors. | When an individual buys a company’s stocks, they become an investor in that company. |
| Risk | Lower risk due to diversification. | Higher risk depends on company performance. |
| Original Issuance | No such possibility. | Possible. |
| Suitability | New and expert investors can benefit from it. | Expert investors with sound market knowledge can have a better chance of performing well in stocks. |
| Knowledge | Having market knowledge is good in mutual funds; however, having a deeper understanding is not necessary. | Investors should be well-versed in every aspect of the stock market to manage their portfolios. |
| Tax Implications | Capital gains tax applies when mutual funds are sold, and the investor redeems their units. In equity mutual funds, short-term holdings for less than a year are taxed at 15%, and long-term holdings for more than a year are taxed at 10% if the holding exceeds ₹1 lakh. Debt mutual funds are taxed according to the income tax slab. | When the investor sells the stocks at a profit, capital gains tax applies. If the stocks are held for less than a year, the profit is considered short-term capital gains (STCG) and taxed per the investor’s income tax slab. If held for more than a year, it qualifies as long-term capital gains (LTCG), and a 10% tax applies on gains exceeding ₹1 lakh. |
| Systematic Plan | Mutual funds come with the feature of a systematic investment plan. | Stocks do not extend the feature of systematic investment plans. |
| Investment Horizon | Most mutual funds give better returns if held for a longer time. | Stock investment can be done for either longer or shorter periods, depending on the investor’s preferences. |
Pros and Cons of Mutual Funds
Mutual funds are convenient investment options for portfolio diversification and professional management, but they come with fees and do not offer higher returns. Let’s go through the pros and cons of mutual funds:
Pros:
- Lower cost: Mutual funds can be cost-effective, especially passively managed index funds, which do not charge a large expense ratio or fee. Some brokerages also offer their funds without trading charges.
- Diversification: A mutual fund provides investors with a diversified portfolio by pooling assets, which helps lower risk. This means investors do not need to buy multiple stocks individually to achieve diversification.
- Less stressful: One of the best advantages of mutual funds is that they are managed by an experienced fund manager who makes investment decisions on investors’ behalf, reducing stress levels and managing everything by leveraging their skills and research capabilities.
- Accessibility: Mutual funds allow even small investors with little investment to participate in diversified investment opportunities.
- Convenience: Mutual funds are a convenient option with features like systematic investment plans (SIPs) and systematic withdrawal plans (SWPs), allowing to automate the investment and redemption processes.
- Liquidity: Mutual fund units are liquid as they are bought and sold based on their net asset value (NAV), allowing to redeem them anytime subject to market conditions.
Cons:
- Fees: Mutual funds are expensive, including management fees, sales charges, and administrative costs. This eventually erodes overall returns over time.
- Risk: Like any investment tool, mutual funds are subject to market risk and fluctuations. Changes in market conditions can impact the value of underlying investments, potentially leading to losses for investors.
- No control: Mutual funds are managed by portfolio managers, who make all the decisions. Thus, investors relinquish control over individual investment choices and transaction timing.
Pros and Cons of Stocks
Stocks offer higher returns to investors when the market performs well, but they also come with their own set of disadvantages. The following are some of the pros and cons of stocks.
Pros:
- Potential for higher returns: Stocks can give higher returns when invested for the longer term, especially in growing startups, well-performing organisations, or emerging sectors.
- Ownership: Investing in stocks gives shareholders partial ownership of the organisation. They can vote and receive dividends, which give them a share of the company’s profit.
- Diversification: Stocks can diversify the portfolio of the investor by investing in a variety of stocks across different industries and even in companies abroad.
Cons:
- Volatility: Stocks are volatile, experiencing frequent price fluctuations and market swings. This can lead to short-term losses and changes in portfolio value.
- Higher risk: One of the major drawbacks of stocks is that they carry the risk of a partial or total loss of invested capital, especially in the case of bankruptcy or poor performance of the organisation.
- Research: Investors must put effort into research and analysis to identify quality companies, understand market trends, and act accordingly.
Conclusion
When it comes to investing, there is no right choice. Investment is a personal decision based on financial knowledge, risk tolerance, and expected returns. If you can take risks and have a good understanding of the stock market, then you can go with stocks. To gain wealth by mitigating the risk, you should consider mutual funds as a plan. However, if you want to diversify your portfolio, you can invest partially in shares and mutual funds.
