A good investor always has an amount set aside for investment during a particular period. But how do they determine how the fund is spent?
As an investor, what would you prefer?
Would you rather invest a larger share of your investment fund directly into one or two companies, or a small investment into a pool of shares that diversifies your investment among many companies to reduce risk?
The decision between these two is quite a dilemma for investors with a few years of experience, and efficient allocation among the two is the best way to maximize gains.
In this case, the former refers to Equity while the latter refers to Mutual Funds.
What is Equity?
Any direct investment by an investor for a stake in profits and assets of the company is an equity investment.
What are Mutual Funds?
Asset Management Companies float funds that invest in bulk in shares across companies, sectors, and even countries. Such funds are called Equity Mutual Funds. In some cases, mutual funds are also investing in government securities or lending money to corporations. These are known as debt mutual funds.
Are they the same?
While in both cases you are a part-owner of the company, there are a few differences. As a direct equity investor, you are relying on your expertise to invest in a company. Whereas, in Mutual Funds, you are depending on an experienced portfolio manager to invest in a fund consisting of what they believe are worthwhile investments. Your total investment is diversified in a portfolio, thus reducing your risk.
Mutual Funds are mostly handled by Asset Management Companies (AMCs). These AMCs have funds that are handled by experts in the field. So if you do not have the required knowledge, an equity investment is riskier than a mutual fund investment. With a Mutual Fund, you can sit back, let the fund manager take control, and watch your money grow.
Another vital point to note is that SEBI has made it mandatory for top employees of AMCs to have a stake in the funds they recommend, so the risk for the managers has made it vital for these managers to curate a well-performing fund.
In a direct equity investment, you are required to purchase stocks in lots consisting of a minimum number of shares. At times, the price of one share can be high, and you may not be able to invest your available funds into it. In these scenarios, a mutual fund comes handy.
Time is a vital factor for this decision. A good investment requires a thorough screening of the company’s financials, the industry performance, and any other external factors. An individual investor may not have that kind of time to scour through the required data. Whereas funds have teams and processes set up for this very purpose.
Mutual funds also provide an added advantage of natural hedging since the investments are generally in different sectors which do not rise or fall at the same time. The risk factor as well as the possibility of gains is much higher when invested in individual equity. The correlation between the investments is low, ensuring diversification. Even in a mutual fund focusing on a particular sector, losses in one company are offset by profit in another. Even in cases of losses across a sector, experts in the AMCs ensure that they divest quickly enough to minimize losses since their responses are quicker than the response by a general investor.
The sum required to invest in mutual funds is lower compared to the direct investment in equity since the AMCs gain the benefit of scale.
Mode of Investments also depends on the service levels of AMCs, management integrity, automation, and user-friendliness for online investments, costs, and such other factors. Due to the competitive nature of business amongst mutual funds, generally in India, service levels have improved. Even at lower levels such as in remote towns, agents, brokers, and counsels are available to guide on such issues. Investments in mutual funds are a much safer mode for the aged, those not having financial acumen, and the working class among others.
