MUTUAL FUNDS VS STOCKS – WHO WINS THE RACE?

Mutual Funds vs. Direct Equity – Who wins the Race?

Is a direct foray into the stock markets preferable over investing in mutual funds? The answer probably lies in the investor’s capabilities. For instance, when we talk about wealth-creating stocks, blue-chip names, such as TCS, Reliance, Infosys, Wipro, etc come to mind. While they have managed to garner great returns in the past 20 odd years, how many investors would have spotted these winners right at the beginning? Not too many, we suppose. However, it would have been relatively easier to identify top mutual funds vis-a-vis top stocks a decade ago. Let us assess these two fine investment options on some parameters:

1) Behavioral Science

A critical element in successful investing is "how you react to feelings of both discomfort during the market's fear cycle and invincibility when markets are booming," writes Marty Leclerc in an article in the Forbes magazine. During periods when share prices drop, he says, data shows that most investors want to end the discomfort (basically stop loss?), which is the "root cause of poor returns.

It is quite surprising that emotions and fear have a link to investing habits. Let us understand this with a simpler example. This is an experiment conducted by a group of scientists as part of understanding behavioral science. A group of monkeys were put inside a cage with a ladder having some bananas on the top. One of the monkeys started climbing the ladder to pick up the bananas. Once it started climbing, the scientists started pouring cold water on the remaining monkeys due to which these monkeys started to beat the climbing one. Water stopped after the first monkey got down. This happened every time a monkey tried climbing the ladder. Slowly, they started replacing these monkeys with a new set of monkeys. However, one change was that they stopped pouring cold water now. These monkeys failed to notice this change and kept beating the monkey which tried to climb the ladder.

This is (in)famously known as the herd mentality. Herd mentality could prove to be disastrous, especially in the investing world. Your reactions to various ups and downs in the market can have a greater impact on the final returns. Patience is the master. The more patient you are, it is highly likely that you beat all odds. It may not possible to be patient or invest systematically in a stock, which can move from East to West in no time. However, by starting a Systematic Investment Plan (SIP) in mutual funds, you can definitely imbibe the patience in your nerves.

2) Investing in top companies

Anyone would love to invest in top companies such as MRF Ltd, Eicher Motors or Bosch. However, can you imagine the prices these are quoting at? They are currently trading between Rs. 20,000-40,000 per share, which puts them out of reach for the average investor. However, a good mutual fund allows you to indirectly obtain a decent exposure to such scrips.

3) Investing regularly in small amounts

It is not quite easy investing small amounts in the same stock every month, quarter or year. It requires keeping track of the stock and sometimes the volatility can get the better of you. In comparison, it is easy to opt for a 10, 15 or 20 years SIP in any of the decade old funds. The best part is that you can actually start off with as low as Rs. 500 per month.

4) Professional Management

We had discussed on how tough it would have been for the common investor to identify an Infosys, Wipro or TCS at the beginning? It is the same case even today. When we lack the knowledge and tools to identify stocks that may turn out to be winners/ losers in the future, it is better to lean on the expertise of a mutual fund (manager). A fund manager possesses all the skills as well as equipment to be able to identify these next-gen stars.

Final Word

The above factors clearly point out to mutual funds as an easier entry option for investors. However, this is not an invitation to move to mutual funds from stocks. If you are already investing in stocks or have the skill-set to pick good stocks from a large universe, persist to make the most of it.

HAPPY INVESTING

Rajiv Kapoor
B.Sc., LLb., FCS
9839034761