Mutual funds vs Direct Equity Investment: What should a young investor prefer?

Equity is the only asset class that has comfortably beaten inflation over the years and created real wealth for investors. As a young investor, you want to invest in equity. But there is a real dilemma on hand – whether to invest directly into equity markets or through mutual funds.

In this post, let us compare both investment options on various parameters to take a more informed decision.

In direct equity, you need to be more careful about managing the risk in your managing portfolio. It can be done as follows:

• Do lots of research on various parameters before buying a stock.
• Buy stocks across sectors and capitalization like large, medium, and small-cap. This will help spread your risk across companies and sectors.
• Fix per-sector and per-stock caps on investment to avoid over-exposure to a single sector/stock.

In mutual funds, risk management is taken care of by the fund manager. When you buy into a mutual fund scheme, you buy into a basket of a minimum of 40-50 stocks across caps and sectors. Your money is managed by a professional fund manager on various parameters.

In direct equity investment, the return potential is very high as compared to mutual funds. But your success is entirely dependent on your stock picking skills & your ability to enter & exit the stock at the right time.

You don’t expect sky-high or multi-bagger returns in mutual funds. Because the fund manager diversifies the portfolio to reduce the risk. The primary goal is to generate a higher return than the benchmark, with the least possible risk.

If you are planning to invest directly in stock markets, you must do the spadework as follows:

• Invest in some courses to learn about equity investing, how stock markets work etc.
• Read up on the day-to-day developments in economy & business.
• Spend some time every month to review the performance of your stocks.
• Open a Demat & trading account.

In mutual funds, the time and effort involved are comparatively significantly less. Most of the information about scheme performance & risk parameters is available online. You can get started with some well-performing schemes having a decent track record. Later, once a year, you can review the schemes and make the necessary changes if needed.

In direct equity, you can buy shares in multiple of 1 share of your chosen stock. Here, you need to be mindful that the share prices of quality companies can be very high. So, depending on your investment amount, you can buy a few shares of each company you plan to invest in. Don’t make the mistake of investing in penny stocks. Focus on quality than quantity.

In mutual funds, there is no such problem. You can invest in any scheme starting as low as INR 500. You can easily change this amount every time you make a new investment as per your available surplus for that month.

Asset allocation is a compelling and systematic way you can reduce your risk in your portfolio. In direct equity investments, you should remember to also invest in debt avenues separately (bonds, fixed deposits, etc.). This is to maintain a proper allocation between high-risk & low-risk assets.

In mutual funds, it is relatively easy. You also have a range of debt & commodity funds (for example, gold funds). They help you diversify your total investment into various asset classes. You can also choose to invest in asset allocation funds. These funds automatically manage the asset allocation depending on the state of the market.

You need to have a proper process and the temperament to navigate volatile equity markets. You can put a stop loss to your holdings & also keep some reserve funds to invest to benefit from low market levels. Most importantly, you need to keep your faith and conviction in your stock picks.

In mutual funds, you can trust your fund manager’s skills to make the right investment moves. You just need to ensure that you ignore market movements & continue with your SIP.

You need to pay brokerage for buying/selling stocks, Demat charges, securities transaction tax & GST in direct equity.

In a mutual fund, there is a fund management charge of around 1-2%. You pay it to get a professional fund manager to manage your money at a very reasonable cost. Further, if you buy direct plans, even this cost gets reduced as you save on the agent commissions.

There is not much difference in the tax treatment of equity mutual funds and stocks. However, if you invest in Equity Linked Savings Schemes (ELSS), you get a tax deduction of up to INR 1.5 lacs under Section 80C. This benefit is not available in stocks.

As we can see above, both options have their pros and cons. However, we feel that as a young investor, you can start off with mutual funds to build a solid foundation for your investment portfolio. As you mature and get comfortable with equity as an asset class, you can consider direct investments to benefit from exceptional opportunities that come your way.