Mutual Funds vs Direct Equity Investing – Which one’s for you?
Equities over a long-term have a potential to create long-term wealth. This is not a secret. We would have read or heard endless stories of great investors making an unimaginable fortune from a small first-time investment they initially started with. There are enough instances of stocks and funds over the years which have created enormous wealth for the investors. However, everything has a flip side. We have a much larger population of investors who have lost a big proportion of their invested amount in equity markets over the years.
As I draft this article, the traditional fixed income instruments are not generating enough returns on investment to beat inflation alone, forget the appreciation. PPF returns have dropped big time over the years and so have returns of FD’s and other small savings schemes. On the flip side, with the high expenditure lifestyle kicking in, medical and education expenses on the way up, uncertain jobs at hand, intent to pursue expensive hobbies while working, an aspiration to travel across the globe – growing your wealth has become a lot more significant than ever. In spite of which designation or position you are at any given point in time, you can’t afford to take your finances lightly. Most of the investors want to grow their wealth but are not sure how to go about it – some invests in traditional instruments such as fixed deposits, KVP’s, PPF, real estate while some prefer to invest directly in stocks or take a mutual fund route.
Since every investor (if haven’t till now) will someday realize the importance of investing in equities – this brings to another dilemma – where to start, especially in a financial instrument which can create enormous wealth for the investor and also has the potential to erode complete investment corpus.
So a retail investor what should be right strategy – direct equity investment or one should take a mutual fund route?
Do share your experiences in the comments section so as for the benefit of our readers.
There is no direct answer as to which is a better investment option as it all depends on your risk profile, investment horizon, your current asset allocation – something which a certified financial planner can suggest you best. There is no single plan which suits everyone. You will need to spend ample time planning with the experts and periodically reviewing it. There is no shortcut here. Every investor has a unique investment pattern, risk-taking capacity, investment horizon and as an investor one should invest only in the product one understands and is aware of the risks involved and return expectations. One should also be cognizant of the expenses involved with a particular investment and the tax implications associated with the investment.
Some questions which you as an investor should ask yourself before taking an investment decision:
- Are you as an investor aware of the inherent risk when you start investing in equity markets?
- How ‘long’ is your ‘long-term’?
- How you as an investor reached a decision as to invest in stocks or mutual funds?
- If you as an investor don’t have any prior experience of equity investments – why you will prefer to take a plunge directly in equities and not start with mutual funds instead? What is the basis for your investment decision?
- Have you are an investor without any prior knowledge of a specific company, its management, market it operates in, its financial performance, sustainable business model or not, at any given point of time have invested a big lump sum amount in the company without due diligence?
- Have you mapped your equity investments to a specific life goal or its a random buy-sell with no prior plan?
- What are your return expectations from your equity portfolio?
- What is your mindset as an investor when your portfolio value goes down drastically in short span of time? – do you invest more or redeem or stay put.
- Do you have a firm belief in every stock in your portfolio that when the stock price goes down, you feel an urge to buy more with the thesis that since a company is an excellent one, it will outperform in the long run once the market stabilizes?
- Do you find mutual funds boring in comparison to equities? Have you yourself analyzed returns of some of the funds over a 15-20 year period as to how much CAGR returns they have provided? Don’t you think 20-25% returns generated by mutual funds is a good return over a long term?
- Don’t you think Equity Linked Savings Scheme (ELSS) funds is a great way to not only save tax but also generate excellent returns over a long term? Have you reviewed returns of some of the tax saving funds such as HDFC Tax Saver, Reliance Tax Saver, BSL tax Relief 96 over a long term? How it fares against PPF or PF as your retirement corpus?
- Are you too much critical of SIP’s that you have rejected them outright as an investment option without knowing its benefits over the long term?
The problem arises when an investor having no prior knowledge of equity markets starts investing directly in stocks only to lose money and shun the equity markets altogether. This keeps happening almost every day to small retail investors who put in their hard earned money into equities without any prior knowledge and experience and expose themselves to a big risk in the process.
Today only as I was watching a business news channel, a viewer had purchased 25000 shares of Unitech and after doing so was asking for a recommendation? Isn’t such an example an eye opener as to what a dis-service some of us as retail investors do to ourselves and all the hard work we put at the job.
So what’s the way out – what you should choose – equity vs mutual funds:
Make a strong portfolio base with mutual funds through Systematic Investment Plans (SIP) and Systematic Transfer Plans (STP) first– In an equity market, time is your biggest asset. Higher is the investment horizon, higher can be the returns. In spite of randomly putting a lump sum amount in a momentum stock without a goal in place, only to realize to have put a huge amount at the market peak and losing big money, it is prudent to develop a habit of systematic investment for a long-term through mutual funds first which will instill great discipline and patience in you as an investor. It is really a mystery when investors investing lumpsum lakhs of rupees in a stock are caught unaware when they see their investment value dip. Why can’t investing in a diversified mutual fund for a long-term goal and moving lumpsum amount in equity funds through Systematic Transfer Plan (STP) be a better option instead as a beginner strategy? A 20% mutual fund compounder over a 15-20-25 year period can generate huge wealth for you as an investor. Lay a strong foundation with mutual funds first. Strictly follow a SIP and STP route. Increase your SIP allocation by 15% every year and map all your investments to your goals. Don’t invest randomly without any purpose. Key here is to start investing early and invest regularly.
Equity Linked Savings Scheme (ELSS) is a great way to create wealth, not just to save tax – Youngsters have no reason not to invest in ELSS funds as part of tax saving instead of insurance policies which majority of them end up with. ELSS funds can be a great way to create wealth and that necessary 3-year lock-in will make sure in your early years you don’t panic or take money out whenever market tanks but just keep investing. For instance, Reliance Tax Saver has generated a neat 18.1% CAGR returns from December 1, 2005, to December 1, 2017.
Simple mantra: Start your SIP’s. Have 5-6 funds in the portfolio. Track progress every 6 months and increase your SIP amount as salary increases. Lastly, don’t delay investing in mutual funds. I have met investors who spent years and years to get convinced to initiate Rs 1000/- monthly SIP in a diversified equity fund. Time lost is an opportunity lost.
Once you have a strong mutual fund portfolio, make a virtual stock portfolio, to begin with – For a novice investor, its always better to shortlist good well managed businesses with transparent management, good balance sheet, good growth, less CapEx and more free cash flow, the market leader in the sector. The investor must decide on the investment horizon before investing. Once done, an investor can make a virtual portfolio and buy/sell as if he/she is buying the actual stock. This way for a specific period of time one can gauge various strategies applied and if some correction needs to be made before putting in actual capital. There is no substitute for hard work in equity markets to succeed as in any other profession. In spite of investing in stocks or mutual funds, you need to keep reading articles, editorials and other material available to make sure you are up to date with happenings which may have an impact on your investments. I am strong a believer in the fact that you should not shun business TV channels as they provide a lot of data points, management interviews, global perspective, policy news etc. to you which you as an investor can utilize for your benefit in making an investment decision.
- Listen, read everything but investment decision you need to make based on your understanding
- Stay put with long-term compounders.
- Look for efficiently managed businesses.
- Don’t buy expensive policies, to begin with, which not only have pathetic returns even in the long run but also drains out your investible surplus considerably.
- Have a core and satellite portfolio in case you have a long-term view on some while for some you may want to book profit time to time.
- Don’t rely on bad businesses or turn around stories. We have so many beautiful stories in the equity markets to make money.
- You can even go SIP way in stocks. This can be a good strategy as in mutual funds.
- Be aware of tax implications before redeeming your investments.
- Don’t invest randomly in stocks based on tips.
- Always have a ‘watchlist’ for yourself for quality businesses you want to buy.
- Never compromise on the quality.
- Decide on good businesses and start investing. Don’t procrastinate investment decisions.
- Don’t look for multi-beggars every year.
- Be patient with your investments and don’t panic in a market downturn.
- Large-cap stocks can also tank 50-60% from its peak.
Once you have enough exposure to equity markets, start your investments in direct equities ( in case you want to) – Now you are good to go and have a strong base in mutual fund SIP’s. Your investment strategy coupled with patience and positive outlook will define your success in the long term. Make sure you don’t sell your mutual fund investments to make way for direct equities. Your SIP’s must continue and should increase with time in line with your goals. All your long term goals, without fail should be linked to mutual funds via SIP’s.
In equities, it is always beneficial to invest in strong businesses for the long term and track them with each passing year.
Why investors miss out on equities instead of its strong growth potential:
- Want to make a quick buck and not having the patience to invest in good businesses for the long term.
- A lot of investors buy 2nd or 3rd-grade stocks based on tips as their first equity investments only to lose money thereafter.
- Looking at stock prices daily and unable to hold on to winning long-term bets.
- Buying in bulk first time instead of staggering the investments.
- Not having a good understanding of the business of stock investing in.
- Accumulate too many stocks in portfolio making it impossible to track it.
- Thinking making few thousands is creating wealth.
- Buying a small quantity of good fundamental stocks resulting in not making a substantial difference in investor’s portfolio returns.
- Investing in cyclical plays which may take years to be back in reckoning.
- Not shown enough interest in steady compounders as they sound boring and generate only steady returns not to the liking of investor.
- The problem is that in the crucial early years when compounding story for you can really start, these decisive years are wasted trying and experimenting the stocks you buy or sell, making some profit or loss in the process. Post that we take a home loan and our only focus is to pay it out over a specific timeframe and approach is that once we close it, then i will start investing. Age you start working till the age of 35 when you all of a sudden realize that with increasing expenses, investment needs to be done diligently, you already have lost 7-8 years of steady cash flow and relative lesser responsibilities wherein you could have really kick started your investments via SIP mode. You can start investing with as low as 500 per month. So if we have any of our readers who is in mid or late 20’s and wondering what to do – best advice you can get is to start investing in mutual funds via Systematic Investment Plans (SIP) for your long term goals.
Disclaimer: Above strategy is just my personal viewpoint and investors must take the advice of professional advisor before taking any investment decision. However, in equity markets also, investors must look at long-term outlook and carefully chalk out their investment strategies. Do share your investment stories, hits and misses with our readers and lessons you learnt from it so that we all can get benefitted.