Mutual Funds vs. Stocks: Which One is Better for Long-Term Returns?
When it comes to investment, deciding between mutual funds and stocks can be a challenging choice. Both options offer different advantages and disadvantages, making it vital to understand their unique characteristics before making an informed decision. This article aims to provide a comprehensive comparison between mutual funds and stocks, focusing on factors like risk, return, management, diversification, cost, investment style, and tax benefits, to help you determine which investment strategy aligns best with your long-term financial goals.
Difference Between Mutual Funds and Stocks Investment
Ownership in a Company
When you buy a share, you become a legal owner of the company, with rights such as voting and receiving a portion of the company's profits (dividends) and the right to attend and participate in the annual general meetings (AGMs). You also have the option to communicate directly with the company.
Earnings from Stocks
Stocks can generate earnings in two major ways: dividends and capital gains from selling the shares. Dividends are distributions of a corporation’s profits paid to its shareholders, while capital gains occur when you sell your shares at a higher price than you bought them.
Investment in Mutual Funds
When you invest in mutual funds, you are pooling your money with other investors to form a diversified portfolio managed by a professional fund manager. Your investment is reflected in the number of units you purchase. While you get a share in the pooled fund, your rights and benefits are restricted to those of the mutual fund house.
Comparison of Features: Mutual Funds vs. Stocks
Risk and Return
Investing in individual stocks involves a high level of risk and potential for high returns. On the other hand, equity mutual funds have higher risk due to the nature of their investments, but they offer diversification across multiple stocks and asset classes, which can mitigate the impact of negative returns on any single stock.
Management
Direct stock investments require in-depth research and management by the investor. Mutual funds, however, are managed by professional fund managers who have access to comprehensive resources and tools to optimize returns. This allows for more reliable and consistent performance.
Diversification
A well-diversified stock portfolio typically includes 15 to 20 stocks, which can be a significant investment for individual investors. Mutual funds, on the other hand, provide access to a diversified portfolio of assets for even small investments, such as as low as INR 1000.
Cost
Due to economies of scale, mutual funds often attract lower transaction costs and lower brokerages compared to individual stock purchases. Additionally, you can avoid the annual maintenance charges of a demat account, which are unnecessary for mutual fund investments.
Investment Style
Direct stock investments require active management by the investor, who is responsible for research, buying, and selling decisions. Mutual funds, however, are managed passively by a fund manager, making you more of a passive investor. This is particularly beneficial for new investors who do not have time or expertise to manage their own portfolios.
Investing / Trading Time
Stocks can be bought and sold at any time during the exchange trading hours (9:15 a.m. to 3:30 p.m.), based on the current market price. Mutual funds, however, can only be bought or sold once a day, typically at the closing net asset value (NAV).
Tax Benefits
Equity-oriented mutual funds offer tax benefits through schemes like ELSS (Equity Linked Savings Scheme), which allows investors to claim deductions of up to INR 1.5 Lakhs under Section 80C of the Income Tax Act, 1961 by investing in tax-saving mutual funds.
Conclusion
Both mutual funds and stocks have their unique advantages and drawbacks. Mutual funds offer diversification, professional management, potential tax benefits, and lower-cost investment options, making them suitable for passive and new investors who want to build long-term wealth. Stocks offer higher potential returns and direct involvement in a company's performance, but come with higher risks and the need for active management. The choice ultimately depends on your investment goals, risk tolerance, and time for active management.