Key Differences Between Stocks and Mutual Funds

It is a historically proven fact that investing in equities for the long term will result in wealth creation. Shares and mutual funds can potentially deliver high returns in the long run. If you are in a dilemma about whether to invest in stocks or mutual funds, then you are not alone. Millions of investors have the same question. But it is important to note that there is no right or wrong choice between the two; it’s a subjective decision. Shares and mutual funds give exposure to equity and can add value to your portfolio. We are not here to tell you which one is right. But we can help you choose by pointing out the differences between stocks and mutual funds.

What are stocks or shares?

A share represents a single unit of ownership of a company. Investors are called shareholders and are entitled to the company’s profits and losses in proportion to their shareholding. There are two types of shares, namely, equity and preference shares. Equity shares have voting rights and receive dividends. Equity shareholders have a say in the company’s important decisions, such as a dividend. Preference shares are entitled to the company’s dividends and are given preference before equity shares at the time of liquidation. However, they do not hold any voting rights.

Shares have the potential to give large gains and can be easily traded on the stock exchange. However, they can also result in huge losses and require investors to do thorough research before investing in them.

What are mutual funds?

Mutual funds pool money from various investors and invest in equity and debt securities based on the investment objective. There are several types of mutual funds, but based on asset class, mutual funds are broadly categorized as equity, debt, and hybrid. Equity funds primarily invest in shares, debt funds invest in bonds and money market securities, and hybrid funds invest in both equity and debt securities.

Mutual funds have several benefits, such as professional fund management and in-built diversification, and have lower expenses than shares. However, they are subject to fund managers’ bias and can underperform when the markets drop.

Differences between stocks and mutual funds

Stocks and mutual funds are not mutually exclusive. If stocks are the parent, then mutual funds are its children. Though both invest in equities, there have several differences. The following table summarizes the differences between the two.

Following are the key differences between stocks and mutual funds:

Meaning

Stocks or shares are units of a company, and each unit represents a part of the company’s ownership. As a shareholder, you will own the shares of the company. In contrast, mutual funds are a collection of shares and debt securities. As a mutual fund investor, you will own units in the mutual fund, not shares of each company the fund invests in.

Investment

In the case of shares, you directly invest in the stock market to get ownership of shares. You invest in mutual funds, through which your investment is directed to different securities.

Management

You manage your own investment in the case of shares and have full control over your portfolio. In the case of mutual funds, a fund manager manages your investments. He does market research on your behalf and invests in shares and securities in line with the fund’s objective. Hence you have no control over the fund’s portfolio.

Return

Equity shares have the potential to give relatively high returns in the bull run. In the case of mutual funds, they can give high to moderate returns in a bull run.

Risk

Investing in shares is considered very risky when compared to mutual funds. This is because you directly invest in shares that are subject to market volatility. In the case of mutual funds, even though they invest in shares, they are less volatile as they invest in a collection of shares.

Shares best suit investors with a higher risk tolerance and are patient enough to sit through short-term market volatility. On the other hand, mutual funds are suitable for investors with both high and low-risk tolerance. This is because there are mutual funds for all kinds of investors.

Performance

A stock’s performance depends on the demand and supply and macro and microeconomic factors. The performance of mutual funds depends on macroeconomic factors and the fund manager’s expertise.

Diversification

For stocks, diversification is possible only when the investor invests in shares of different companies across various sectors and themes. In the case of mutual funds, an investor can achieve diversification by investing in just one fund, as a mutual fund invests in at least 20-30 stocks.

Trading

You can buy and sell shares throughout the day at market price on the stock market. Mutual funds can be bought and sold only once a day at the net asset value (NAV), which is determined only once a day.

Expenses

You will have to pay brokerage and transaction charges to buy shares from the stock market. You will incur transaction charges every time you buy and sell shares. There is a fixed expense ratio for mutual funds, which includes management fees, transaction charges, and marketing fees. Asset management companies deduct expenses from NAV every day before declaring it.

Market knowledge

To invest in shares, you must have the market knowledge and the time to study the market. It is impossible to manage your equity shares portfolio without having knowledge about the market. In the case of mutual funds, you do not require market knowledge as the fund manager does the research and invests in shares on your behalf. However, market knowledge in the case of mutual funds can be rewarding.

Convenience

To invest in shares, you must have a demat and trading account. Opening the account and trading in shares can be a cumbersome process. Mutual funds are convenient as you can invest within minutes through different online platforms with zero paperwork.

Flexibility

Mutual funds allow you to invest in lumpsum or through installments (SIP). You can invest a specific amount through SIP every month. However, in the case of shares, even though you can set up a SIP, it requires constant monitoring of the markets and can often lead to concentration. Moreover, you cannot invest in shares in fractions, and the investment amount might vary every month due to market dynamics.

Tax benefits

Shares don’t offer any special tax benefits. Investment in equity linked savings scheme (ELSS) qualifies for tax deduction up to Rs 1.5 lakhs under Section 80C. However, they come with a lock-in of three years. Also, only investment in ELSS funds qualifies for a tax deduction. The returns from mutual funds are taxable, just like returns from your share investments.

To sum up…

Both shares and mutual funds can be rewarding investments. You don’t have to choose one between the two. However, before investing, you must consider several factors, such as your income, risk tolerance levels, market knowledge, and goals. Invest in shares only if you have the time and knowledge to manage your portfolio, else go for mutual funds and let the fund manager take the stress of market research.

Remember, both shares and mutual funds can be valuable investments in the long term. So whatever you choose, be patient with your investments. The earlier you start investing in your life, the higher your wealth will be. Start investing if you haven’t already.

Happy Investing!