When it comes to stock market investing, there is always confusion among budding investors whether they should start investing directly in stocks or go through mutual funds. If you are new to stock/ share market investing, you must first clarify what exactly are stocks and mutual funds and their differences as well.
In this article, I’ll help you to understand primarily the difference between stocks and mutual funds as well as their comparative advantages and disadvantages in layman’s terms.
Stocks and Mutual Funds:
The stocks of a company refer to the same proportion of ownership in that company. The entire share capital of a public company is equally divided into small- small portions called equity shares.
If you purchase a share of any company which are listed in the stock exchanges, at the same time you buy the one unit of ownership in that company and you will be entitled to get profit share known as a dividend in which proportion you hold the shares.
All in all, if you invest in stocks, you directly invest your money in the company and you will get a dividend periodically (typically in every financial year) and you might earn a capital gain due to appreciation in the share price.
Read Also, Difference between Shares and Stocks
Mutual funds, on the other hand, are the investment vehicles which collect and pool money from various retail investors and then invest such collective funds in financial securities such as stocks, bonds, FD or debentures to make profits. In addition, mutual funds are regulated and managed by the professional fund managers having years of experience in the stock market investing, hence mutual funds are less risky than stocks.
In fact, mutual funds are the indirect way of investing in the stock market for the new investors who don’t have sufficient knowledge regarding the fundamentals of share market.
Now let’s discuss head to head difference between stocks and mutual funds to understand their features and limitations in brief.
Stocks vs Mutual Funds (Comparison Table):
|BASIS OF COMPARISON||STOCKS||MUTUAL FUNDS|
|Meaning||It represents the ownership in the company and provide returns in terms of dividends and capital gain.||It is the collective funds pooled from large number of investors managed by professional fund manager and provide returns in a fixed range.|
|Investment Monitoring||Investors themselves||Fund Managers|
|Expenses of Investment||Less||More|
Difference between Stocks and Mutual Funds:
The stocks and mutual funds have their own pros and cons and can be distinguished on the basis of various vital aspects as follows.
1) Returns Potential:
When it comes to returns on investment, stock market investing is one of the best platforms and the returns potential is much higher than other modes of savings/ investment. As we know the stock market is a highly volatile market, the prices of stocks fluctuate in the stock exchange all the time. If we compare returns potential of stocks and mutual funds, investing directly in stocks have great potential to make profits in the long run, however, one can lose his money as well.
On the other hand, mutual funds (highly rated) are known for providing consistent returns but returns potential is less than stocks. Once you buy a mutual fund, you actually buy the stakes in such funds and you will get returns in which proportion you hold share.
2) Investment Risk:
The second major aspect of stocks and mutual funds investment should be risk associated with them.
Whenever one invest directly in stocks, he himself responsible for managing his portfolio. You have to make decisions yourself such as what stocks and when to buy or sell the shares. Moreover, if you are a newbie investor the chances of getting lost would be higher.
On the other hand, mutual funds are carefully managed by the professional and most experienced fund managers. In addition, it is a diversified portfolio hence funds invested in various other securities instead of stocks. Therefore, the risk associated with fluctuation in the price of securities minimises due to diversification of funds.
Thus investing directly in stocks is riskier than mutual funds.
3) Investment Monitoring:
You should become a good observer/ monitor if you are going to invest money in the stock market. You will have to do your own research and should be frequently updated with regular news and activities regarding the stock market.
Moreover, if you invest directly in stocks, you need to do all the research by yourself and have to take significant decisions as well. However, in mutual funds, all such stuff is performed by the fund managers, hence you needn’t worry about such observations.
4) Tax Benefits:
In case of mutual funds, if you hold ELSS mutual funds (Equity Linked Saving Schemes), you will get a tax rebate up to 1.5 lacs under 80C of Income Tax Act. In addition, you needn’t pay taxes during sales or purchase of any stock, if the fund manager does so.
On the other hand, in case of stocks, there are no such tax benefits during the sale of any stock irrespective of any circumstances instead you’ll have to pay the taxes at the rate 15% on short term gain (up to 1 Lac) and 10% on long term capital gain (above 1 Lac).
The stock market is a highly volatile market wherein the price of securities is determined by real-time demand and supply. Hence volatility in investment should be one of the significant aspects of comparison between stocks and mutual funds.
Mutual funds are diversified portfolio and funds are invested in different securities such as bonds, stocks, debentures, fixed deposits etc therefore volatility in investment is less due to broader diversification.
The stocks, on the other hand, is highly volatile because an investor generally buys the stocks of 10-15 companies into his portfolio. Thus volatility in case of mutual funds is very less as compared to the stocks.
6) Expenses of Investment:
Mutual funds typically charge expense ratio and load fees which generally vary 2- 3% depending upon which types of mutual funds you have purchased.
On the other hand, while investing directly in stocks, you need to open a Demat account and pay the brokerage charges on every transaction as well as annual maintenance charge.
If we compare the cost of investing in stocks or mutual funds, investing in stocks are still cheaper than mutual funds.
Hope you have understood the fundamental difference between stocks and mutual funds. In a nutshell, we can say as mutual funds carry relatively low risk hence the beginners should first start investing with mutual funds then they should go with stocks later.
However, the stocks are comparatively highly risky but at the same time earning potential is also high in case of stocks. It depends on the person whether he has to take more risk to gain more or go with mutual funds for a comparatively safer investment.
References: Cleartax- Stocks vs mutual funds (source)