Before we enter the debate of “Mutual Funds vs Stocks” – the readers must understand that by the term ‘stocks’ we mean direct equity investing.
Direct equity investing undoubtedly offers outsized returns over time. The reason for this is fairly simple – no other asset class comes close to being as productive as businesses.
But if that is the case, why do mutual funds exist? Why don’t people invest directly in stocks? Why are comparisons like “Mutual Funds vs Stocks” constantly drawn?
Written below is a guide for you to understand whether direct investing is for you or not.
Just because you can invest directly, doesn’t mean you should.
Why the answer to Mutual Funds vs Stocks is tough
Investing is simple but not easy. The issue here is that investing is a personal activity that involves both your intellect and your temperament. For reasons such as this, we cannot answer such a question for you. All we can do is provide you with specific questions, and you can make a value judgment yourself.
The questions are to be answered, keeping your ego aside. There are no medals for bravery in the stock market – returns matter, whether you get them from investing in funds or by investing yourself.
When to choose a Mutual Fund
- When you invest via a mutual fund, professionals manage your money. The manager might be a CA, a CFA, a business graduate but somebody who knows the industry inside out. The chances of you losing money in a mutual fund are much lower than investing by yourself. If you don’t know anything about the stock market – do not pick stocks by yourself. It is more fun but incredibly harmful.
- If you do not have the time to track business activities, pick a mutual fund. The globalized economy is dynamic; business models change very quickly. Business models are moving from Cloud to BlockChain to AI, and unless you see the changes coming your way – you won’t be able to survive in the stock market. In such a case, it is better to choose a mutual fund.
- You are in your 40s and need money for retirement; therefore, the money is much more critical for you – if you are not sure about your ability to pick stocks, choose a mutual fund. Younger individuals can hit and miss – you cannot.
Do note that we are not implying that investing in your 40s is a bad idea. We intend that the money holds more value to you than it would to a young adult, and for this reason, you ought to be more careful.
Buying stocks: A DIY
If you are young, have enough time to track businesses, and have knowledge of the stock markets, you are better than most, but that is not it. A few more critical questions need to be answered.
- Do you look at stocks as businesses or pieces of paper with dynamic prices?
- Can you keep your wits about you during adversity?
- Do you have the stomach to digest losses?
- Do you know the edge of your competence, and are you willing to stay inside your circle of competence?
Unless you think of stocks as a part of a business, you shouldn’t be in stocks. You shouldn’t be in stocks unless you can see your stock price decline by over 30%. Unless you can identify the edge of your competence and have the courage to say, “I don’t know,” – you should not be in stocks.
Our aim is not to scare you but to tell you that it is not as easy as it seems. The benefits of this due diligence, however, are extraordinary. Direct equity investing allows you to participate in a company’s growth story and make as much money as the company.
HDFC bank has made money for its shareholders.
ITC has been amongst the best-performing companies in India.
Infosys has been the biggest wealth creator for investors in Indian history – Infosys gave a 30% CAGR for 25 years!
If you adjust for splits and other activities, your returns would be close to 35%. This implies that an investment of 10,000 in 1993 would translate to 2 crores(back in 2018 – much higher now)!
If you can pick stocks on your own, your minimum return expectations should be 15% because a zero-risk index investment yields that. However, in order to generate the Alpha(i.e. The excess above the market returns), you need to understand the paragraph below.
Baby steps to generating an Alpha
You need to understand 2 things properly.
- Do you understand the business properly?
- What is your edge?
These two go hand-in-hand.
- For Example, let’s say you are a manager at Tata Steel.
You know the business inside-out and you know when the demand is rising because all of that is happening in front of you. Therefore – you can buy the stock of the company whenever you feel that the demand is rising and make multi-bagger returns. This simple activity of yours will give you better returns than Mutual Fund managers because they have no idea about the fluctuations in demand and they do not know the company as well as you.
- But what if you don’t work at a manufacturing company? What if you are a parent working at an MNC?
You still have an advantage over fund managers. If you were a student, it was impossible to miss Maggie. As a parent, it was impossible to miss Cerelac. A working professional thrives on Coffee, it would have been tough to ignore Nescafe. All of these products(and many more day-to-day products) are sold by one company – Nestle. You could’ve done a SIP on Nestle stock on the first of January every year over the past 10 years and have made about 18% returns.
That is how simple it is, not easy, simple. Always keep your eye out for opportunities, look for businesses that you understand, and you can easily beat Mutual Fund managers.
Mutual Funds vs Stocks – what’s better for you?
Ultimately, there is no definite answer to the “Mutual Funds vs Stocks” debate – there cannot be. It depends from person to person.
Investing in a Mutual Fund is much safer than investing in stocks by yourself. Investing in stocks directly requires a lot of knowledge and due diligence. You need to look at the overall industry, where the company stands in the industry, what the future prospects of the company are, whether the company is presenting fake accounts – mutual funds on the other hand are safer because a professional does all of the due diligence for you. A mutual fund is diversified and is handled by a team of professionals who do it for a living.
Direct equity investing requires skills and time but offers outsized returns, If you don’t have either of these – you should choose a mutual fund. The returns will not be as good as direct investing but will ensure wealth creation nonetheless.