Equity Mutual Fund vs Direct Equity — Wondering What To Choose?
The recent up-move of benchmark indices has resulted in many opting to invest directly in equity. But is it a sustainable scenario? Let us discuss what is a good way to invest, equity mutual funds or direct equity?
The world has changed a lot and since the outbreak of the Covid-19 pandemic; things are not the same they were a year ago. The dynamics have changed globe over. Not only on the social front but also on the business front. The world of investment is also not an exception. We are not speaking only about the equity benchmark index levels testing yearly lows and then achieving new highs during the Covid-19 pandemic. But we are speaking about the way equity market penetration has increased during this period. Just put the numbers in perspective, from 40.10 million trading accounts in India in February 2020, the number has gone up to 47.6 million trading accounts in October 2020. And the benchmark indices have been moving northwards since April 2020, considering conservative growth of new opening of trading accounts — the number might have easily crossed the 5 million mark by now (February 2021).
Strong traction in new equity trading accounts
There have been many reasons that resulted in the rapid growth of new trading account openings in India. While many faced salary cuts, some lost jobs and opted for trading as an additional way to earn. Further, technological platforms like discount broking and online trading made things easier for them. Lastly, adding to that returns (consistent returns), the equity market generated in the last 10 months (starting April 2020) has attracted many new investors in a big way.
Mutual funds also gained momentum
While the direct equity participation has increased, the exposure to equity related mutual funds schemes has also increased. To put the numbers in perspective, the retail plus high net-worth individual exposure to equity-related schemes in March 2020 was to the tune of Rs. 7,73,427 crore. This has increased to Rs. 11,40,965 crore in December 2020, up by 47 per cent.
Both the segments have witnessed a good traction, however, the returns generated through the direct exposure to equity would be higher than what the mutual fund investment has generated. That’s why, there was confusion in the minds of investors if one should go direct equity exposure or should opt for equity mutual funds? Let us discuss the pros and cons of both investment options.
Risk taking capacity is an important factor
Investors always have a recency bias. This means the decisions they take are based on the recent historical events. Similarly, the way equity benchmark indices have moved since April 2020 — giving a lot of success to the newly entered investors. Everyone would prefer equity over equity mutual funds. However, one must understand that this is a rare scenario. Equity markets are volatile and despite the long term compounded annual growth rates (CAGR) being higher than mutual funds; everyone is unable to take the volatility in equal capacity.
The risk is completely different in equity and mutual funds. In other words, direct equity exposure is always high risk — high return proposition. While there is a possibility of earnings higher returns, there is also a chance that the investor may end up with negative returns. Even though equity mutual fund schemes have a higher risk due to the asset class they invest in, they have a diversified portfolio. Such diversification is not possible in individual equity holdings. On the back of diversification and the ability of fund managers to stabilise the equity mutual fund portfolios, any negative return on a single stock can get compensated by the returns generated by another stock in mutual funds.
Diversification — mutual funds score high even at lower sum
As mentioned earlier, diversification has many benefits. A well-diversified portfolio should include at least 15 to 20 stocks, but that might be a huge investment for an individual investor. Just imagine how much diversification one can manage if he only has Rs. 5,000 to Rs. 10,000 to invest? Diversification is hardly possible. However, as in the case of mutual funds, one can get a diversified portfolio even if the investment is as low as Rs. 500 to Rs. 1,000. Buying units of a fund allows the investor to invest in multiple stocks without the need to invest a huge amount. The best of the fund managers in the industry are hired at no additional cost with minimal investment.
Tedious process of research and tracking the portfolios
One benefit a mutual fund provides is that one need not always to pick a stock. In equities, picking stocks, tracking them, making sector and asset allocation, buying and selling stocks when required, need a consistent follow up and time. However, in the case of mutual funds, after selection of a mutual fund scheme (aligned with one’s financial goal), it is the duty of fund managers to carry out research and allocation. And we opine, it is usually best done by a professional fund manager.
There have been cases where investors start equity investment with enthusiasm, but eventually as the work gets tedious and returns hardly appear, they start losing interest. And the end result is stagnant portfolios. A few portfolios after a few years become so obsolete that many stocks in those portfolios that get completely defunct or in many cases hardly provide any exit route. In a mutual fund, the investor can avoid such situations completely. It is managed by a professional fund manager who will ensure that the portfolio contains good stocks with potential for long term returns. Further, the kind of network, research capabilities, financial software and connection with company management mutual fund managers have got — individual investors would hardly get an access to such advantages.
Taxation — advantage mutual funds
When one manages a portfolio of stocks of direct equity exposure, it is natural to churn the portfolio on a regular basis. A lot of buying and selling of equity stocks occurs. Some may be long term and some may be short term. If the selling of stocks is done within one year of purchase, there is an incidence of short term capital gains tax. However, in the case of investment in mutual funds, for a fund manager, there is no capital gains tax. Even if it were to book short term capital gains for the fund, they manage it. This comes in as benefits for investors in the mutual fund. The taxation factor comes in for mutual funds investors only when the amount is withdrawn by selling units.
Focus on core competency, not markets
Financial investment is an expert domain and hence also requires a lot of focus, time and dedication. It may be simple but definitely not easy. One may be an expert in their own field. A person may be a great tech-programmer, sales person or an expert in a particular domain. It is always advisable to stick to the domain one is an expert in and this would probably end up in the person earning more. If we try to earn from core professions along with trying our own hand on investing as well — it may not end up good. We advise the investor to leave investing to the specialists. And mutual funds investment exactly helps in that. Just imagine working out parallel on equity investment and the core profession is a difficult task. Not everyone would be able to multitask such a way.
Conclusion: We are not suggesting avoiding direct equity investment. Equity investment can be more profitable and worthwhile if one is willing to spend time. Time spent on analysing, tracking and researching companies and sectors. If one can handle volatility and has an adequate investable sum to build a diversified portfolio. Else, those looking to grow safely, trying to beat the inflation and higher than risk free returns, a mutual fund seems to be a good alternative.
Pro Tip: Never test the depth of the river with both feet. Start an investment journey with equity mutual funds. And when one achieves a critical mass — direct equity exposure route can be adopted.
