Software programmer Ankur is a new investor. He wants to save and invest for his future. After talking to several experts, the vote is in favour of equity as an asset class for building wealth and fulfilling longterm goals. However, there is a mixed view on how to go about investing in equity— directly or through equity mutual funds. He wants to know what would be the best route for him.
Stocks can be easily bought and sold through brokers but it becomes the investors’ responsibility to manage their portfolios and take the call on buying and selling. On the other hand, mutual funds are managed portfolios where the investor purchases the units and the fund manager manages the portfolio. Typically, investing in individual stocks is a task best done by investors who understand stock markets and have the time to research. Ankur, being a new investor, should probably start with investing in equity mutual funds as they are managed portfolios, handled by trained professionals who are skilled and equipped with resources.
Equity mutual funds are less risky compared to direct stock investments, as their portfolios are diversified with a fairly large number of stocks. At any given point in time, against those shares that fall in value, there are those that gain. Investments in individual stocks can be an emotional affair when compared to mutual funds and many investors get stuck with buying at the top and selling at the bottom. Or not selling at all. It takes patience and experience to know when to use price dips to increase holdings of undervalued stocks.
It also takes skills to sell off what is not working and manage the amount invested in each stock, so that the winners contribute to the portfolios’s return. While it is true that managed portfolios come with a set of fees and expenses, these expenses are limited and regulated and therefore, reasonable. Direct equity investors incur brokerage charges when investing in stocks through a broker. They also incur tax liability on sale of stocks at a gain, within a year of purchase. Mutual fund transactions do not have a direct tax implication for the investor.
It is important for Ankur to understand both the available options well before investing his money. The lure of stock trading is tough to resist, but may have more risks than Ankur can comprehend and manage. The benefits of equity funds may not be so obvious given the focus on risk management and diversification. Ankur should try a bit of both and make up his mind based on experience.