With the election process set into motion, most investors are optimistic that a new government would result in a positive sentiment. But many are confused about whether they should invest directly in equities or take the mutual fund route. In fact, the decision depends on the individual, his risk appetite and his fundamental knowledge of stock markets. Let us take a look at the pros and cons of entering the financial markets via either of the routes.
Mutual funds
Mutual funds are, by far, one of the most popular investment vehicles. Although each one of us wants to explore equity markets to generate returns that can offset rising inflation, more people eventually end up losing money than gaining any substantial reward. MFs offer investors an opportunity to use the services of an experienced fund manager who creates the portfolio and makes investments on behalf of all individuals pooling in their money into the fund.
For people not open to the risky equity market route, there are mutual funds that invest in debt financial instruments. Apart from being safe and secure, debt mutual funds offer higher returns than fixed deposits. Mutual funds are ideal for people with a little higher risk threshold, but who are not aware about the day-to-day operations of the equity market.
Another advantage of equity mutual funds is the tax-free return and no exit load after a year. Mutual funds investments, therefore, are ideal for people who plan to stay invested for a minimum period of one year.
With systematic investment plans (SIPs), mutual funds allow individuals to invest each month as they go along to build a substantial portfolio over the year. The dividends or returns offered by mutual funds can be paid out to the investor or reinvested into the fund as per the individual choice of the investor. Further, mutual funds allow tax benefits of up to R1 lakh under Section 80C of the Income Tax Act when one invests in equity-linked savings schemes (ELSS) which have a three-year lock-in period.
Direct equity investment
While direct equity investment could be exciting, it is a specialised task and, unless one is totally aware of all investment details, it could be a dangerous play.
Investing in individual stocks directly gives users the option to choose and select individual company stocks depending on their research. One is free to create his or her own portfolio rather than being dependent on the whims and fancies of a mutual fund manager.
If one stock is not performing as per expectations, the user has the option of selling and replacing it with a better performing stock.
As a shareholder of stocks of companies, one is entitled to attend general body annual meetings. Investing directly in the equity market is useful only for those who have an understanding of the fundamental and technical analyses of the underlying stock. Anyone entering the equity market directly relying on tips or cheap advice from so-called experts is more likely to lose money.
Technical analysis help traders purchase and sell stocks on a daily basis, something which is not entirely possible in a mutual fund. Along with profits on shares, individual investors are entitled to dividends on stocks. For more experienced and advanced investors, derivative trading under the futures and options market is possible, which can offer high returns, albeit at a higher risk.
The direct equity route is open for everyone, including short-term, medium-term and long-term investors. However, tax benefits are allowed to first-time equity investors under Section 80CCG (Rajiv Gandhi Equity Savings Scheme) on shares or stocks with a lock-in period of more than a year.
The final decision of choosing the best investment vehicle or between the mutual fund or direct equity routes depends on various factors. For an amateur investor or a new entrant, mutual fund is by far the most reliable tool to enter the financial markets.
Experienced investors, on the other hand, can choose to go directly in the equity market. One of the golden rules of investing is to never put all eggs in the same basket. A perfect investment plan is one that divides the overall investment proportionately. So, there is a case for investors using both the mutual fund and direct equity routes to attain a good investment portfolio.
Adhil Shetty
The writer is CEO of BankBazaar.com
