Mutual Funds vs Stocks: Whats the Difference?| North Loop Official Blog
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10 Apr 2020

Mutual Funds vs Stocks: Whats the Difference?

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Mutual Funds vs Stocks: What's the Difference?

We often get asked, what’s the difference between investing in a mutual fund and investing directly in stocks. Well, there’s a lot!
Investing in stocks vs mutual funds are very different financial tools for investment - they have different returns, risk, and are used for different goals and financial planning. The method by which you invest is also different, as well as the techniques and subsequent taxes.

Difference Between Mutual Fund and Stock Investment

When you’re investing directly in a company by buying shares, you are effectively becoming a part-owner of the company. Every share is a ‘share’ of the company. Depending on the company’s bylaws, this can mean that you get voting rights, a dividend (part of the company’s profits), and participate in the Annual General Meetings of the company.

Investors profit from investing in the stock market through 1) the rise in the stock price, and 2) the dividends they receive per share they own.

Buying stock, however, is direct participation in the Stock Market, the earnings from which can be in two ways:

Investing in a mutual fund, however, is slightly different. You are giving your money to a fund manager, who will pool your money in with other investors and buy different financial securities (such as stocks or bonds). You don’t become a part-owner of the companies that the fund invests in (the mutual fund takes on those rights). The profits you get will be from the sale of your units in the mutual fund, or the dividends the mutual fund distributes (if the mutual fund chooses to do so).

Think of it this way - if you borrowed money from a friend and invested in stocks, you would be the part-owner of the company, not your friend. Similarly, with mutual funds, while it is your money they are using, they assume the ownership and voting rights.

So you may end up investing in stocks indirectly through a mutual fund. Learn how to invest in mutual funds.
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Difference Between Mutual Fund and Stock Dividends

Mutual funds have two options regarding the return of dividends. Dividend option - the mutual fund shares the dividends it receives from its options. Growth option - the mutual fund reinvests the dividends back into investments.

When you invest in stocks directly, this is your judgement and research and knowledge that is determining the investment. With a mutual fund, there are countless analysts and managers doing thorough research to identify the correct investments, as well as when to rebalance.
Now that you understand the difference between mutual funds and stock market investments. Now let’s compare the features of stocks and mutual funds to understand which option is better for you.

Remember, the true key to a strong portfolio is diversification! When you invest directly in stocks, make sure you are well diversified across different sectors. Now you can also invest in US stocks with North Loop. With mutual funds, the managers do this for you as they aim to make their funds well diversified for returns.

If you’re new to the stock market, you aren’t sure how well you will do - after all, you have no past performance as a benchmark! With a mutual fund, you can check its annual returns and see if these have lived up to expectations.

Mutual Fund Vs Stock Investment

Here are some of the key differences between a mutual fund and direct stock investment:
1. Risk and Return
Generally speaking, it is riskier to invest directly in the stock market vs. investing in a mutual fund.This is why most people largely rely on mutual funds for their retirement plans. Buying an individual stock has a high risk high return potential. Equity Mutual funds, through diversification and their knowledge, hedge and ensure that negative returns on some stocks are compensated by high returns on other stocks.

2. Management and Experience
Unless you are a well-trained and knowledgeable and experienced investor, it will be difficult to compete with the management of a mutual fund. Mutual funds are filled with individuals who are doing research, have great knowledge and years of combined experience. What’s more, they will be less susceptible to bias e.g. many individual investors use logic like ‘I’ve heard great things about this company so I should buy its stock’. Mutual funds do careful research, due diligence on a scale not possible for an individual investor.

3. Diversification
To get a well diversified portfolio, you’ll need at minimum, 20 stocks, all weighted equally. You will then need to constantly rebalance these stocks to ensure diversification stays the same, and one or two stocks don’t change the holding makeup of your portfolio. This is both expensive and time-consuming - you won’t be able to build a diversified portfolio with Rs. 1,000 if you do direct stock investing. However, you can do this with mutual funds as they will take your Rs. 1,000 and give you a unit in the mutual fund that represents a well-diversified portfolio.

4. Trading Hours
If you’re buying stocks directly, you can do this during trading hours (9:15 a.m. to 3:30 p.m) and you can do this multiple times a day. With mutual funds, you can only buy or sell units once a day, at the end of the day, when the NAV is determined.

5. Tax Benefits
If you invest in ELSS mutual funds, you can get tax exemptions up to Rs. 1.5 lakhs. You don’t get any tax benefits for investing directly in stocks.

Why Mutual Funds Are Better

1. Professional Management
A mutual fund has qualified managers who spend all of their time analyzing, tracking and managing its portfolio and investments. This Is the job of the fund. Unless you are a full time investor, it will be difficult to get both this expertise but all time and dedication to do this.

2. No Taxes on Short Term Gains
If a stock has skyrocketed, and you are looking to capitalize on the gains. If you sell it within the first year, you will pay 15% Short Term Capital Gain (STCG) tax on it. However, if the mutual fund has invested in it, they will not pay the tax, therefore their gains are 100% (not 85% due to you paying the tax). This will benefit you as a unit-holder of the mutual fund, as your gains will be more.

3. Diversification
Diversification is key to a good portfolio! To do this, if you are investing in stocks, you will have to invest in a variety of stocks (at least 20) and do this through a balanced investment of weighted ratios.
But if you invest in a mutual fund, they do this for you - a Rs. 500 investment will get you a diversified portfolio vs. having to make multiple investments that add up if you are investing directly.

4. Easier to Invest
To invest in a mutual fund, you don’t need a demat account. More importantly, for NRIs, you don’t even need a PIS account - you can use your NRO account!

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This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended be advice. You must obtain professional advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax, investment or other professional advice from North Loop or its affiliates. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. All opinions expressed do not reflect the views of North Loop nor are endorsed by North Loop.