Stocks vs. Mutual Funds: A Comprehensive Comparison

The day I started investing, I faced this question: Should I invest in stocks or mutual funds? I'm sure there are a lot of new investors who face the same question.

So, which option is better: stocks or mutual funds?

Well, honestly speaking, there is no fixed answer. Both stocks and mutual funds have their own set of pros and cons.

For example, while stocks have high return potential than mutual funds, mutual funds balance the risk better than stocks.

In this article , I have tried to compare both stocks and mutual funds with their pros and cons. At the end , I have also concluded which option is better.

Then there is another common question: How many stocks or mutual funds should you hold in your portfolio?

Investors , Mutual Funds are themselves very vast. You have active vs. passive mutual funds, equity vs. debt mutual funds, sectorial mutual funds, direct vs. regular mutual funds, and so on.

Difference Between Stock and Mutual Fund

So, the basic difference between equity mutual funds and stocks is that when you invest in a particular stock, you take ownership in a particular company.

For example, if today you buy shares of HDFC Bank, you take a small ownership in the company.

For example, if one share of HDFC Bank is Rs. 1500, you need to shell out Rs. 1500 to get one share. You can't invest Rs. 750 to get 0.5 shares.

But when you invest in a particular equity mutual fund, you take ownership in multiple companies.

Although this ownership is not direct, it is indirect. For example, let's say you invest in a large-cap mutual fund that has 50 stocks in the portfolio.

In that case, you will have indirect ownership in 50 companies. It means even if you invest Rs. 500, you would still have ownership in 50 companies.

So, let's say out of 50 stocks, ITC has 10% weightage in the overall portfolio. In that case, out of Rs. 500, 10% would be invested in ITC. But here you don't hold the direct ownership; you buy the mutual fund units and not the stocks directly.

Now, let's understand the pros and cons of both investment styles.

Stock vs. Mutual Fund: Pros and Cons

The benefit with stock investment is that you are the decision-maker of the stock buy or sell, whereas in mutual funds, you can't decide which stock to buy or sell. So, with stocks, you have direct control over your investment.

If today you like Asian Paints, you can buy it. Tomorrow, if you want, you can sell the shares of Asian Paints.

But with mutual funds, your fund manager decides which stock to buy or sell in the portfolio.

The benefit of stock investment is that you hold direct ownership in the company, whereas the disadvantage with mutual funds is that you can't hold direct ownership.

For example, when you buy stocks, you own them. But when you buy mutual funds, you own the units of the mutual fund and not the direct stock.

Next, in individual stocks, there is high return potential, whereas in mutual funds, you can't expect multi-bagger returns.

For example, if today you invest in Polycab, then you can expect maybe around 10 times return in the next 10 years.

But if you invest in mutual funds, you can't expect 10 times return in 10 years. It is simply because of the fact that in mutual funds, there are multiple stocks, and hence if a particular stock rises, there would be another stock that would fall, and that would average out the returns.

However, the disadvantage with individual stocks is that it is a high-risk game and there is no diversification.

But with mutual funds, you reduce your risk due to diversification.

For example, if today you think that the pharma sector is rising and you invest in a specific pharma company and if tomorrow, due to any reason, the company falls, then you will face loss.

However, with mutual funds, you can invest across companies across sectors.

For example, it could include pharma, IT, banking, FMCG, etc. So, if the pharma sector falls, maybe the banking sector could rise.

There have been cases where a lot of investors lost money in the stock market by investing in the wrong companies.

So, there is high risk with stocks, and with mutual funds, your risk would reduce due to diversification.

Next, in stocks, you need to do your own research. It requires a lot of time and energy.

But with mutual funds, it is the fund manager's headache. So, if you're someone who has a job or business, it is difficult to keep track of each stock's performance.

However, with mutual funds, you can just invest and relax.

Next, in stocks, systematic investment in stock is very difficult, whereas with mutual funds, it is very easy.

The most difficult decision with stock investment is: Should you buy if a stock is at an overvalued state?

For example, let's say you invested in AFL India last month. Now, today you got your salary and you want to invest more money, but AFL India has become overvalued.

Now, will you invest? The majority of people would not have the courage to invest at higher levels, so they would keep waiting for the stock price to fall.

In that case, sometimes they lose the opportunity to invest. Whereas with mutual funds, you can set up an SIP, so every month a specific amount would be invested in that fund, and it would be the fund manager's headache to identify the undervalued stock and rebalance your portfolio.

Here we are talking about active mutual funds. We are not even talking about index funds; that is a different discussion altogether.

Now, in stocks, you don't need to pay any fee, whereas in mutual funds, you need to pay a fee that is the expense ratio. Again, a big differentiator.

When you buy or sell stock, and I'm assuming that you invest with zero brokerage companies, you don't need to pay any money as commission.

Of course, there are some transaction-related charges, but they are minimal.

However, when you invest in mutual funds, you end up paying an expense ratio of around 1% when you opt for the direct plan.

Although this expense ratio would vary from mutual fund to mutual fund, and of course, if you take index funds, then the expense ratio is very less.

So, for example, if your investment value is Rs. 5 lakh and your average expense ratio with mutual funds is 1%, then you will end up paying Rs. 5000 as a fee.

Next year, if your investment value should be Rs. 10 lakh, then you will end up paying Rs. 10,000 as a fee, and likewise.

In stocks, even if the market is overvalued, you can identify undervalued stocks. In mutual funds, if the market is overvalued, you would end up investing at overvalued levels.

For example, currently, Sensex is at the level of 81,867.55 . Now, the majority of stocks are at an overvalued state at current levels.

If you invest in mutual funds, you would end up investing in those overvalued stocks as well.

However, with individual stocks, you can still identify stocks that are not overvalued. Of course, it is a very difficult task to identify those undervalued stocks.

Next, you can't reduce your tax liability with stocks, but you can reduce your tax liability with mutual funds.

With mutual funds, you can reduce your tax liability up to Rs. 1.5 lakh by investing in ELSS mutual funds under section 80C.

So, the question is: Should you invest in stocks or mutual funds? Now, there is no fixed answer to this question.

Both mutual funds and stocks have their own set of pros and cons.

At the end of the day, it depends upon your risk vs. return profile. Individual stocks are a very high risk and high reward game. There are many stocks that have created wealth for investors.

However, at the same time, there are wealth destroyers. The most important thing in stock investment is to spend time and energy to do the research and identify the right stocks and then keep track of their performance.

But if you are someone who has a job or business and does not have the time and energy for research, then mutual funds are a better solution.

How Many Stocks and Mutual Funds Should You Hold in Your Portfolio?

Well, there is no fixed number. You can hold as much as you can track. But generally speaking, six to eight mutual funds are good enough for a balanced portfolio, and in the case of stocks, somewhere around 15 to 20 stocks can be good enough

So, that is all about stocks vs. mutual funds. I hope you found this analysis insightful. If you have any questions, please leave them in the comments below. And don't forget to like, share your thoughts and ideas ,

We'll meet again next time with new information. Jai Hind!

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