Understanding the Difference Between Equity and Mutual Funds

Equity investment and mutual fund investment are both popular choices for long-term financial growth. However, they have fundamental differences. Mutual funds involve pooling funds from multiple investors, which are then managed by professional fund managers to invest in a diversified portfolio of stocks, bonds, or other assets. This approach provides investors with access to a diversified investment portfolio without needing to directly manage individual securities. On the other hand, equity investment involves directly purchasing shares of specific companies listed on the stock exchange. Investors in equity investments have the autonomy to select and manage their own portfolio of individual stocks, exposing them to the performance and risks associated with those specific companies. In this comparison, we’ll explore the distinctions between equity and mutual funds.

The Core Difference Between Equity and Mutual Funds

As an investor, it’s crucial to assess the disparities between mutual fund and equity investments before making a decision. Factors to consider include:

1. The Risk-to-returns factor:

The risk-to-returns factor is all about understanding how much risk you’re taking on compared to the potential rewards when you invest in stocks or mutual funds. When you invest directly in stocks, you’re essentially concentrating your investment in a single asset class. If the companies you’ve invested in do well, you could make a lot of money. But if the market takes a downturn, all the stocks in your portfolio could lose value at the same time, which means you could lose a lot of money too. That’s why people say “high risk, high returns” about stocks. On the other hand, with mutual funds, you’re spreading out your money across many different investments, which helps lower your risk. There are different types of mutual funds. Some focus on stocks (equity mutual funds), which can offer higher returns but also come with higher risks. Others focus on bonds (debt mutual funds), which tend to be safer but offer more modest returns. You can also find hybrid funds that mix stocks and bonds to balance risk and potential returns. So, when comparing stocks and mutual funds, it’s important to think about how much risk you’re comfortable with and how much potential return you’re looking for. Depending on your preferences, you might find that mutual funds are a safer and more appealing option.

Control over investment:

When investing in mutual funds, investors entrust the management of their money to professional fund managers. Investors simply select a mutual fund of their choice and invest their money. Fund managers utilize their expertise to allocate funds with the goal of achieving growth. They are responsible for determining the stocks to buy and sell within the mutual fund. On the other hand, when investing directly in stocks, investors have the opportunity to choose which companies they want to invest in. While this offers flexibility, it can present challenges, particularly for novice investors who may find it daunting. Some individuals may base their investment decisions on various factors, which can introduce risk. Additionally, even experienced investors may face uncertainties in the outcomes of their investments, particularly during sudden fluctuations in stock prices. However, investors also have the autonomy to select the specific stocks they wish to invest in, rather than relying solely on fund managers for decision-making.

3. Tax Benefits

When you make money from stocks, you’ll likely have to pay taxes on those profits based on your income tax rate. If you hold onto your stocks for less than three years before selling them, you’ll have to pay short-term capital gains tax. If you hold onto them for more than three years, you’ll have to pay long-term capital gains tax. On the other hand, when you invest in mutual funds, there are some tax benefits you can take advantage of. For example, if you invest in Equity Linked Savings Scheme (ELSS) mutual funds, you can get a tax deduction of up to INR 1.5 lakh per year under Section 80C of the Income Tax Act. Also, any profits you make from ELSS mutual funds up to INR 1 lakh per year are tax-free. However, if your profits exceed INR 1 lakh, you’ll have to pay a 10% tax on the amount exceeding INR 1 lakh. It’s important to note that ELSS investments come with a mandatory lock-in period of 3 years, meaning you can’t withdraw your money before that time.

4. Trading and liquidity

When you invest directly in individual stocks, you have the flexibility to buy and sell them whenever you want. These stocks are considered liquid assets because you can easily trade them on the stock market at any time. Similarly, you can also buy and sell mutual funds whenever you choose. However, there are some differences. When you trade mutual funds, you need to pay attention to the cut-off times. These are deadlines set by the mutual fund company for buying or selling shares to get the same or next business day Net Asset Value (NAV). NOTE: Net Asset Value (NAV) is a term commonly used in the context of mutual funds. Think of it as the price per share of a mutual fund. It represents the total value of all the assets (like stocks, bonds, or other investments) held by the mutual fund, minus any liabilities (like fees or expenses), divided by the total number of shares outstanding. So, when you hear that the NAV of a mutual fund is $10, for example, it means that if you were to buy one share of that mutual fund, it would cost you $10. The NAV can fluctuate daily because it’s based on the current value of the fund’s investments. If the value of the investments goes up, the NAV goes up, and vice versa. In simple terms, NAV helps investors understand how much each share of a mutual fund is worth at any given time. It’s an important metric for evaluating the performance and value of a mutual fund. Most mutual funds are liquid, meaning you can trade them easily. However, there’s an exception with Equity Linked Savings Scheme (ELSS) funds. ELSS funds have a lock-in period of 3 years, during which you can’t withdraw your money. So, they’re not as liquid as other mutual funds.

5. Costs of investment

When you invest in mutual funds, there’s a fee called an “exit load” that the mutual fund company charges when you sell your investment. This fee is like a small charge for selling your shares and it’s deducted from your profits. While the fee isn’t usually very high, it can still reduce the amount of money you make from your investment. On the other hand, when you buy and sell individual stocks, you don’t have to pay an exit load. Instead, you’ll typically pay a small fee called a “brokerage fee” when you buy or sell stocks. This fee is usually a small percentage of the total value of your investment, and it’s paid to the brokerage firm that helps you make the trade. In conclusion, instead of viewing mutual fund investments and equity investments as competing choices, it’s advantageous to consider incorporating both into your investment strategy. By diversifying your portfolio with a mix of mutual funds and individual stocks, you can enjoy a range of benefits, including stable to high returns, portfolio diversification, and risk mitigation. This balanced approach allows you to capitalize on the strengths of each investment instrument while mitigating their respective weaknesses. Ultimately, creating a well-rounded investment portfolio that includes both mutual funds and equity investments can provide you with greater opportunities for long-term financial growth and stability. And if you’re looking to enhance your knowledge and skills in the finance domain, consider exploring the cfa course offered by EduPristine. As the best online cfa prep course, we provide top certification in the finance sector and have been ensuring student success for over 11 years. With qualified faculty boasting 15+ years of corporate experience, comprehensive study materials, mock tests, and career services, our CFA® course prepares students for well-paying job prospects in MNCs. Plus, our re-approval by the CFA® Institute for multiple years underscores our commitment to delivering quality education aligned with their rigorous standards. Learn more about, cfa course in india and cfa foundation course, and take the first step towards advancing your career with EduPristine!