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20 Aug 2020 by Pradeep U
Should You Invest In Mutual Funds or Direct Equities? - Research & Ranking

With inflation in the range of 5-6%, the real rate of returns of small savings schemes like bank fixed deposits and post-office have fallen sharply in the last few years. Same is the case with Kisan Vikas Patra (KVP) and Public Provident Fund (PPF). So, the question remains, is there any better alternatives for investment?

If you are regular TV viewer or listen to the radio, the chances are very high that you may have constantly across the slogan “Mutual fund sahi hai” which promotes the benefits of equity investing through mutual funds.

The biggest argument in favour of investing in equity through mutual funds is that it there is a lower risk as compared to direct equity investing as your investments are managed by a professional fund manager.

This however is not entirely true. Remember the disclaimer we come across after every mutual fund ad:

 “Mutual Funds are subject to market risk. Please read all Scheme related documents carefully before investing. Due to the nature of the underlying investments, the returns or the potential returns of a mutual fund product cannot be guaranteed. Historical performance, when presented, is purely for reference purposes and is not a guarantee of future results”.

The above disclaimer clearly states that there is market risk involved and past performance cannot guarantee that in future the performance will be repeated.

So, this puts at rest the biggest argument in favour of investing through mutual funds is that it there is a lower risk as compared to direct equity investing.

However, that is not all. As an investor, there are few important other factors too which you should be aware of.

Let me explain this to you in detail below:

Lack of control over portfolio when you invest in mutual funds

When investing in a mutual fund you don’t know exactly where your money is getting invested and in what ratio. Full control of your portfolio lies with the fund manager who runs it.

Over-diversification is a big problem when you invest in mutual funds

Yes, it is important to diversify one’s portfolio, but over-diversification has its own pitfalls. Most mutual funds have around 30 to 40 stocks or more.

As the number of stocks in your mutual fund investment goes up, the risk becomes low but potential gains are also reduced considerably.

You cannot average during market corrections when you invest in mutual funds

Your mutual fund portfolio may contain outperforming as well as non-performing stocks. When there is a considerable correction in the stock market, you cannot choose more of performing stocks by purchasing buy additional units of the mutual fund as your investment gets divided among different types of stocks.

Don’t forget the charges involved when you invest in mutual funds

The administrative and fund management charges on your mutual fund investment reduce the overall return on your investment. And do keep in mind that these are charged irrespective of whether your fund performs well or not.

Moderate returns

The returns of your mutual fund investment totally depend on the fund manager’s skill and judgment. It is well known fact that very few portfolio managers are able to beat the market.

On an average the returns generated by mutual funds range between 12 to 14% in the long term. But if your rationale behind investing in mutual funds is to capitalize on the high returns of equity, doesn’t direct equity investment make more sense?

Especially when direct equity investments in the right opportunities have the potential to generate as high as 30 to 40% returns.

When the markets are in bull-run, both equities and mutual funds deliver impressive returns as compared to fixed deposits, PPF's or Pension Schemes. Coming to the returns, many investors commit a mistake of comparing apples with oranges. If you've invested in mutual funds, then your overall direct equity portfolio needs to be compared with the returns of your mutual funds' scheme. Again, the composition of mutual funds i.e. growth funds, dividend funds depends on the overall objective of the fund.

As aptly quoted by John C Bogle, Former CEO of Vanguard "Surprise, the returns reported by mutual funds aren't actually earned by investors."

While investing in direct equities, the returns are crystal clear. Also, these returns depend on the selection of the stocks in your portfolio. If these stocks are selected carefully, then equities have the potential to deliver 10x-20x-50x or even more in the long run. If we look at the past, many stocks such as Eicher Motors, Maruti Suzuki, MRF, Page Industries, HDFC Bank, Reliance Industries, Bajaj Finance, CEAT, Amara Raja, etc. have gone to register returns of 20x and more in the last decade.

Let’s understand how direct equity investing is better than investing in mutual fund with the help of an illustration:

Assuming if you invest Rs. 1,00,000 in a mutual fund scheme which delivers a CAGR of 13% the value of your investment would be Rs. 1,84,300 at the end of 5years.

On the other hand, if you invest the same amount in direct equity the value of your investment at CAGR of 30% would amount to Rs. 3,71,400. A difference of a whopping Rs. 1,87,100.

Now isn’t that a huge difference? Imagine the returns would be even higher at a CAGR of 35% or 40%. It is indeed quite possible for direct equity investments to generate such amazing returns.

Yes, it is not easy for every investor to master direct equity investing as it requires a lot of time and skills to analyse financial reports like balance sheet, P&L reports and annual reports etc of companies.

Lastly, many investors opt for investing in mutual funds as investing in equities requires identifying the right stocks and a lot of efforts. However, with more than 2000 primary mutual fund schemes in India, selecting the right mutual that suits your goal and risk requires equal efforts.

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Bottom Line

Due to volatile nature of equity, risks are there in both mutual fund and direct equity investing. However, the benefits of direct equity investing far outweigh the benefits of investing in mutual fund. Apart from adequate diversification and potentially higher returns, you are also in total control of your portfolio. Plus, you know which stock you are investing in and also why when you invest with the help of expert.

Start investing in direct equity now and take a giant step towards your financial goals.

 

 

 

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