Stock Market Vs Mutual Funds: Key Differences

The debate over investing in the stock market vs mutual funds is quite common among investors. While both options offer the opportunity for long-term wealth creation, they’re not exactly the same. Some swear by shares, others advocate for mutual funds. Beginners see these differing opinions and often feel confused about where to start. 

To give you the bottom line first, the choice depends on your goals, risk appetite, and market knowledge. So to pick the right option, you need to understand how both work. Here, we’ll see what each one offers, compare them, and look at the pros and cons. By the end, you’ll know how to choose the option that fits your needs.

Understanding Stocks

People also know stocks as shares or equities. Investors can buy shares of a company through the stock market and become part owners of that business. If the company does well, more investors want its shares, and the stock price moves up. But if the company underperforms or market sentiment sours, the stock price falls. In the first scenario, you can make a profit by selling at a higher price (capital gains) or through dividends. In the second, you face losses if you sell at a lower price.

How Does Stock Investing Work?

Stock exchanges like the BSE and NSE list many companies. You can buy and sell stocks on these exchanges through a demat account. Once you’ve opened an account with a broker, you can use the trading platform to start investing. Search for the company you’re interested in, and place a buy order for the number of shares you want. The broker will charge a small fee for the trade, and the shares will get credited to your account.

Investing in stocks comes with both high risk and high return potential. A share’s price can touch the sky in a blink, and fall back down just as quickly. That’s why people often take a long-term perspective when investing in stocks. Throughout the trading hours, a stock’s price fluctuates based on demand, supply, company performance, and market sentiment. There are two ways to earn here:

• Capital Gains: These refer to the profit made upon selling stocks at a higher price than they were bought. Based on how long you held these shares before selling, capital gains can either be short-term or long-term. Short-term capital gains (STCG) apply when you sell within a year. On the other hand, long-term capital gains (LTCG) apply when you hold them for more than a year. Each category has different taxation, so the holding period impacts your returns.
• Dividends: Capital gains can only be realised when you sell your shares. But what if you want to stay invested and still earn an income? Well, some companies share a portion of their profits with shareholders, called dividends.

Selecting the right stocks requires a ton of research and analysis. You need to study the company’s financial statements, how it operates, its position in the sector, and its growth potential. Evaluation of factors like revenue, profit margins, debt, and management is essential. Then, you have to contextualise these with market sentiment and economic indicators, as these also affect stock prices. That’s why investing in stocks is considered high-risk and requires knowledge and patience.

Features of Stocks

• Direct Ownership: A stock makes you a part-owner of a company. For example, if a company issues 100 shares, and you own 5, you own 5% of that company. This ownership allows you to attend shareholder meetings and receive a part of the company’s profits as dividends. Direct ownership is one of the main differences between stock market vs mutual funds.
• High Risk: Stocks are high-risk investments. Their prices fluctuate throughout the day depending on market sentiment, the company’s performance, or economic factors. A well-established company’s stock is generally more stable compared to a newer company, so the riskiness also varies depending on the company’s size and financial health.
• High Return Potential: Stocks can deliver huge returns over the long term, making them an attractive option for aggressive investors.
• Capital Appreciation: Investors can earn profits by selling stock as its price rises above the purchase price.
• Liquidity: Stocks can be easily traded on exchanges via brokerage apps.

Understanding Mutual Funds

Mutual funds are investment vehicles, so rather than investing in them, you invest through them. All investors pool their money, which is then managed by professional fund managers. These managers use the pooled fund to invest in a diversified portfolio of stocks, bonds, and other securities. Right off the bat, you gain major advantages such as diversification, professional management, and convenience. You don’t have to research or choose stocks yourself. You simply invest your money, and an expert manager handles everything.

Thanks to these benefits, mutual funds are considered safer than picking individual stocks. The returns may be relatively lower, but they still offer the potential for high returns in the long run. Also, all mutual fund houses must follow SEBI guidelines, which ultimately protect investors’ interests.

Exactly where and how the money is invested depends on the fund’s objective. For example, a large-cap fund will invest at least 80% of its assets into large-cap stocks. Similarly, an aggressive hybrid fund invests about 65% to 80% into equities while allocating some in debt to reduce risk. There are three main categories of mutual funds:

• Equity Mutual Funds: These types of schemes primarily invest in shares of companies. Examples include large-cap funds, multi-cap funds, and ELSS.
• Debt Mutual Funds: Here, the main underlying asset class is debt. These funds invest in instruments like bonds, CPs, CDs, T-bills, and government securities.
• Hybrid Mutual Funds: This category bridges the gap between equity and debt funds.

Since we are comparing stock market vs mutual funds here, we’ll stick to equity-focused mutual funds, i.e., the ones that invest mainly in stocks.

How Do Mutual Funds Work?

When you invest through a mutual fund, you don’t own the fund’s underlying stocks. Instead, you’re buying the units of the fund. The value of these units is the NAV or net asset value. The NAV reflects how well the fund’s assets perform. If the underlying stocks do well, the NAV rises, and so does the value of your investment. Conversely, if the stocks underperform, the NAV and your investment’s value fall. Unlike stocks, a fund’s NAV changes only once at the end of each trading day.

Let’s say you invest Rs. 1 lakh in a flexicap fund with an NAV of Rs. 20. This means you would receive 5,000 units (1,00,000 / 20 = 5,000). After a year, the fund performs well, and its NAV rises to Rs. 25. Now the value of your investment becomes Rs. 1,25,000 (5,000 * 25). If you decide to sell your units now, you’ll book a capital gain of Rs. 25,000. This is one way to earn returns from a mutual fund. Another way is through dividends. Some funds distribute payouts to unit holders, which provide a regular income without the need to sell any units.

Features of Mutual Funds

• Diversification: Diversification reduces risk. Let’s say you invest heavily in just a handful of stocks. By doing so, you run the risk of losing a large chunk if even one of them performs poorly. Mutual funds minimise this risk by spreading your investment across many companies, sectors, and asset classes. For example, a large-cap fund may invest in well over 50 stocks. This level of diversification is not something that most retail investors can easily achieve.
• Professional Management: A fund manager working with a team of qualified analysts makes all decisions.
• SEBI Regulation: SEBI regulates the mutual fund industry in India. They set guidelines on asset allocation, disclosures, and expense ratios. This ensures transparency and adds a layer of protection for investors.
• Liquidity: One can easily buy or redeem their units at the prevailing NAV. To sell a stock, you need a buyer willing to purchase it at your desired price. But with mutual funds, the AMC itself buys back your units. If the fund is close-ended, however, its units are either traded on the exchange or redeemed upon maturity.
• Systematic Investment Plans: SIPs are among the most attractive features of mutual funds. You don’t need a large up-front sum to start investing. You can make fixed contributions at regular intervals to slowly create wealth. Many mutual funds allow investors to begin with as little as Rs. 100 per month.
• Rupee Cost Averaging: This is a feature of SIPs. When you make regular instalments, you invest regardless of whether the market is up or down. Thus, you buy more units when prices are low and fewer units when prices are high. This brings down your average cost in the long run.
• Variety: Mutual funds have something to offer to every type of investor. Stocks are risky, and generally, only those with a strong appetite and long-term horizon should invest in them. Mutual funds cater to a much larger variety of investors. A Mutual fund advisor can assess your profile and guide you towards the most suitable funds for your needs.
• Convenience: Investing in mutual funds is simple and requires minimal effort. There’s no need to research stocks or track the market daily. You don’t even need a demat account. The fund manager handles all the decisions, allowing you to focus on stuff that matters most to you.

Stock Market Vs Mutual Funds: Key Differences

Let’s dive straight into the main differences between stock market vs mutual funds:

Stocks: Pros and Cons

Pros

• Stocks have the potential to deliver big returns in the long term.
• Trading stocks is convenient thanks to investment platforms.
• You can control which companies you want to invest in, when to buy or sell. In other words, you retain complete control over your portfolio.
• Liquidity is much higher compared to other assets. However, it is still affected by market conditions.

Cons

• The potential for high returns comes at a cost. Stocks are highly volatile and can lead to significant loss of capital.
• In terms of time and effort, stock investing is demanding.
• It’s crucial for investors to be able to analyse stocks. They should understand how various parameters affect a company’s performance and stock price.
• One needs to have absolute control over impairing emotions such as greed and FOMO to succeed.

Mutual Funds: Pros and Cons

Pros

• Mutual funds offer instant diversification. Your money is invested in a number of securities across companies, sectors, and asset classes.
• Professional managers and their team of qualified analysts make decisions for you.
• SIPs eliminate the need for large lump sum investments. You can make regular contributions and watch your wealth grow thanks to compounding interest.
• With funds, there’s no need to research and track stocks individually.
• Mutual funds can be used to achieve a variety of goals. For example, a Mutual fund consultant might recommend using equity funds to build a retirement corpus. Similarly, a liquid fund can be used to create an emergency fund.
• Units can be easily redeemed with the fund house.
• There’s no need to open a demat account to invest in mutual funds.

Cons

• Mutual funds are subject to market risks. While risk is considered higher in the stock market vs mutual funds, funds like sectoral funds can carry extreme risk.
• Expense ratios for actively managed equity funds can be high.
• You cannot decide which securities the fund manager invests in.
• A fund can underperform its benchmark while being actively managed.

Stock Market Vs Mutual Funds: Which One is Better?

And we finally arrive at the big question – stock market vs mutual funds, which should you pick? While the choice depends on your goals and risk tolerance, it also massively hinges on your investing knowledge and style. Consider the following important factors as well:

• The time and effort you’re willing to dedicate: If you can take the time to research companies and market trends, stocks can be a good option. It allows you to pick good companies and potentially earn higher returns. But ask yourself this – can you consistently deliver better returns than a similar equity fund? Is the time and effort required worth it?
• Your knowledge and expertise: To invest in stocks, one needs to have a certain level of financial literacy. If you can understand markets, balance sheets, and valuation metrics, stocks may be an option. If you don’t have in-depth knowledge, mutual funds can be the answer.
• Your risk tolerance: Stocks are highly volatile. If you are comfortable with fluctuations, you can consider direct equity. Mutual funds reduce this risk through diversification. They’re better suited if you prefer a relatively steady investment journey. If you are a conservative or moderate investor, then you should consider mutual funds. They offer a much wider range of options to match your risk level and financial goals.
• Your experience: For newer investors, mutual funds would comfortably be the better pick. You can automate investments through SIPs and slowly reach your goals.

In fact, you don’t have to choose just one! For example, if you enjoy staying involved in investing, you can pick stocks while also running an SIP on the side. This way, you get the fun of tracking stocks while enjoying the benefits of a mutual fund. The best way to make the right choice is by consulting a professional. A Mutual fund consultant can help you in this endeavour. They can suggest suitable funds and ensure your portfolio aligns with your goals and risk appetite.

Conclusion

Stocks and mutual funds are both great tools to create long-term wealth. For most retail investors, mutual funds do the job. They offer diversification, professional management, and the convenience of SIPs, which makes investing much easier. Direct equity provides the potential for higher returns but demands time, effort, and market knowledge. In the end, the choice between stock market vs mutual funds depends on your risk tolerance, investment horizon, and how actively you want to manage your money.

FAQs for stock market vs mutual funds

Q: What are the risks involved with stocks and equity mutual funds?

A: Stocks and mutual funds both carry market risk. Mutual funds are not as risky as individual stocks because your money is spread across many companies. Diversification and a long-term approach help manage these risks.

Q: What is the main difference between stock market vs mutual funds?

A: Investing in stocks means buying shares of companies and becoming a direct owner. A mutual fund pools money from many investors, and a fund manager invests it in a number of shares. With stocks, you handle the analysis and decisions on your own. With mutual funds, a professional manages everything on your behalf.

Q: What are the different types of mutual funds?

A: Common types of mutual funds include:

• Equity funds: Large-cap, mid-cap, small-cap, and multi-cap funds.
• Debt funds: Liquid, money market, gilt, and overnight funds.
• Hybrid funds: Balanced advantage funds and equity savings schemes.

Q: Which is safer between the stock market vs mutual funds?

A: Between stocks and equity funds, equity funds are considered safer because they spread risk across multiple assets. Individual stocks can be very risky.

Q: How should I choose the right option between the stock market vs mutual funds?

A: Understand your risk tolerance, investment horizon, market knowledge, and financial goals. Consult a financial advisor who can provide personalised guidance.