Imagine choosing individual TV channels vs a Set-top box package. What is easier? Of course, packages are pocket-friendly and hassle-free. But we are talking about stocks vs mutual funds, right?
Exactly! We can consider stocks as individual channels and mutual fund schemes as a set-top box or OTT package. Selecting and purchasing even a single quantity of individual stocks can be challenging, just like subscribing to individual channels can be expensive.
Also, individual choices could differ, where some might be a fan of daily soaps, or K-drama or sports and news. Just like that, buying individual stocks might not match an individual’s risk profile and financial goals.
Therefore, a switch-over to mutual funds, which are like the OTT of investments can be beneficial.
Check for mutual funds based on types, sector and returns here.
What are Mutual Funds?
Mutual funds are like a package deal of securities or asset classes like stocks, bonds, commodities (gold and silver) and more. You can invest in mutual funds through a mutual fund scheme.
While mutual funds are like packages, the mutual fund schemes are like television/entertainment brands. So, to choose a scheme that fits your needs, you can compare various similar schemes from different Asset Management Companies (AMCs).
There can be various mutual fund schemes of different mutual fund types. For example, an equity mutual fund scheme can invest in stocks as a major part of their underlying assets. Similarly, debt mutual fund schemes invest in debt securities in majority and so on.
Furthermore, there are mutual fund schemes that can invest in a mix of asset classes like equity, debt, and more. These schemes fall under the category of balanced mutual funds.
Start investing in Index Funds.
What are Stocks?
When you buy a company’s stock, you buy the part ownership of the company. This means, you also earn profits and bear loss as the company experiences profit and loss.
But how does stock market volatility work?
When more and more people purchase stocks of a company, the demand for it increases and it becomes dearer. Therefore, the stock price rises.
Similarly, when more and more people start selling or redeeming stocks, the stock becomes cheaper. Therefore, the price of the stock plunges.
This rise and fall in the stock price is called stock market volatility. It is more off like a trend. For example, in case of good macroeconomic figures, there can be investor optimism and majority of trades are placed for stock purchase. Similarly, in case of economic uncertainties like inflation, unemployment or geo-political contagion, there would be negative investor sentiment, making the market plunge.
Ability to Average: Mutual Funds vs Stocks
The Stock market is more volatile in the short-run than in the long-run.
Mutual funds investments have two methods, SIP (Systematic Investment Plan) and lump sum. SIP is a method of regular, disciplined and systematic investment in assets.
So, by setting up a SIP amount and SIP date, you can invest a fixed amount every month. This means, you invest a fixed amount on the same date every month. This automatically covers different market conditions and can balance out your risk.
With this process of cost averaging or rupee cost averaging, your portfolio invests equally during market peaks and plunges. Thus, you buy more units when the market is down and lesser units when it is peaking. The buys during peak are automatically averaged out when you get more units during the plunges.
In stocks, however, this strategy of averaging out can take a bit of an effort. This is because you need to track the market and the stock and place orders manually to buy the stock at a low price. And, as the common saying goes “you cannot time the market”. So, you might end up falling prey to various investment biases.
Mutual funds SIPs, however, are non-manual. Hence, they can help us be free from various investment biases like herd mentality, loss aversion and more. They can automate the investing process and the cost averaging process.
Compounding in Mutual Funds
Another feature in the mutual funds vs stocks debate is compounding.
Investing in mutual funds through SIP over a longer duration can give you compounded returns.
Compounding is nothing but returns on returns. These returns are represented in the form of XIRR in mutual funds. Thus, the longer the time you stay invested and continue your SIPs the more compounded would be your returns.
Mutual Funds vs Stocks Returns
In stocks, you can get returns in the form of rise in the price of stocks and dividends. When the current market price of a stock rises above your buy price, you can earn a profit.
Suppose, you bought a share at ₹100/share. Now, if the share price rises to ₹120/share, you will earn a profit of ₹20/share.
However, in mutual funds, your returns are in the form of XIRR. The value of your investment rises with the rise in the Net Asset Value (NAV) of your mutual fund scheme. The NAV of a mutual fund scheme is the current market value of all the underlying assets in a mutual fund scheme. Therefore, if the market value of these securities change, the NAV of the mutual fund scheme too changes.
Table: Mutual Funds vs Stocks
Here is a table that compares the features, benefits, and limitations of mutual funds vs stock investments:
Are you tired of picking stocks to diversify your portfolio? Don’t worry, index funds can help. Explore here.
Wrapping Up
From our introductory example, it is upon the investors to choose between investing in mutual funds vs stocks based on individual preferences, financial goals, risk appetite and portfolio diversification needs. Both mutual funds and stocks are investment products that can serve different investment objectives. Therefore, a balanced approach to goal-based investing with professional advice from an investment advisor can be better.
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch here: Is UPI Killing the Toffee Business?
