Is direct stock-picking smarter than investing in mutual funds? Each has its pros and cons, and its important for the investor to understand this before he embarks on an investment spree.
Investors with profound insight in stocks and investments with the requisite time and skill to analyse companies can do their own stock-picking. However investors who lack any one or all these pre-requisites are better off by investing in stocks through mutual funds. Funds offer several important advantages over direct stock-picking.
Investing in stock(s) directly has one serious drawback – lack of diversification. By putting all his money in just a few stocks, the investor subjects himself to considerable risk should even one of those stocks fail.
A fund by investing in several stocks tries to overcome the risk of investing in just 3-4 stocks. By holding say 15 stocks, the fund avoids the danger that one rotten apple will spoil the whole portfolio. Funds own anywhere from a couple of dozen stocks to more than hundred. A diversified portfolio can generally holds it own even if a few stocks get wiped out.
2) Professional management
No matter how sound an investment sense a stock investor may have, sooner than later he will realize that active portfolio management requires considerable more skill, not to mention a lot of time. There is an ocean of a difference between part-time investment management and full-time fund management.
On the other hand, the mutual fund investor does not have to concern himself about the current prospects and potential of companies in the portfolio. Mutual funds are run by skilled professionals who continuously monitor these companies.
3) Lower entry level
There are few quality stocks today an investor can enter into, with just Rs 3,000-5,000. Investing in stocks can be a pretty expensive affair. Sometimes with as much as Rs 10,000 an investor can buy just a single stock.
The minimum investment in a mutual fund may be as low as Rs 3,000. This implies that with just Rs 3,000, a mutual fund investor can take exposure in a fund portfolio of 20-30 stocks. The entry barrier in mutual funds is low so as encourage investor participation at a broader level.
4) Economies of scale
By buying a handful of stocks the stock investor loses out on economies of scale. This tends to pull down the profitability of the portfolio. If the investor buys/sells actively, the impact on profitability would be that much higher.
Due to frequent purchases/sales, mutual funds incur proportionately lower trading costs than individuals. Lower transaction costs translate into significantly better investment performance.
5) Plans/services for unitholders.
By investing in the stock market directly, the investor deprives himself of various innovative plans that are offered by fund houses to their investors.
Fund houses offer automatic re-investment plans, systematic investment plans (SIPs), systematic withdrawal plans, and they allow investors to make exchanges or switches between funds. These plans facilitate investments and this is something the investor can never duplicate on his own.
A stock investor may not always find the liquidity (or lack of it) in a stock to his liking. There could be days when the stock is hitting the up/down filter and buying/selling is curtailed. This does not allow him to enter/exit a stock.
Mutual funds make very liquid investments. Some times a mutual fund may be more liquid than other investment avenues. For instance, there are days when there are no buyers or sellers for an individual stock. On the other hand, an open-ended fund can be bought/sold at that day’s NAV by simply approaching the fund office.
7) Safety from loss.
Companies going under outnumber mutual funds going under. In other words, investing in mutual funds assures more safety of investment than investing directly in stocks.
A mutual fund may lose money, but may not go down as easily as a company, bank or financial institution. The legal structure and stringent regulations that bind a mutual fund safeguard a unitholder’s interests far better.
As highlighted above, investing in mutual funds has some unique benefits that the direct stock investor would be hard put to duplicate. By no means are we insinuating that mutual fund investing is a sure-fire way of logging growth. This can be done even by investing directly in stocks. However, mutual funds offer the investor a relatively safer and surer way of picking growth minus the hassle and stress that has become synonymous with stocks over the years.