Investing in financial instruments is a common avenue for individuals to grow their wealth and achieve their financial goals. Two popular options that often come into consideration are mutual funds and shares (also known as stocks). Both offer opportunities for potential growth and returns, but they differ in various aspects, including their structure, risk profile, and investment strategies. Let’s explore the differences between mutual funds and shares, how to invest in them, and tips for making informed investment decisions.
What are mutual funds?
Mutual funds are a type of investment vehicle that pool money from a group of investors and invest it in a variety of assets, such as stocks, bonds, and money market instruments. This allows investors to diversify their risk and achieve their financial goals easily. Investors own the units allotted to them by the mutual and do not have ownership of underlying assets. Bajaj Finserv Platform is a leading mutual fund investment platform in India that makes it easy to invest in mutual funds.
Pros and Cons of Mutual Funds
- Diversification: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities, reducing individual investor risk.
- Professional management: Mutual funds are managed by experienced fund managers who make investment decisions on behalf of investors, leveraging their expertise and research capabilities.
- Accessibility: Mutual funds offer accessibility to investors with varying investment amounts, allowing even small investors to participate in diversified investment opportunities.
- Liquidity: Mutual fund units are bought and sold based on their net asset value (NAV), providing investors with liquidity as they can redeem their units anytime, subject to market conditions.
- Convenience: Mutual funds offer convenience through features like systematic investment plans (SIPs) and systematic withdrawal plans (SWPs), enabling investors to automate their investment and redemption processes.
- Fees and expenses: Mutual funds charge fees and expenses, including management fees, administrative costs, and sales charges, which can erode overall returns over time.
- Lack of control: Investors in mutual funds delegate investment decisions to fund managers, relinquishing control over individual investment choices and timing of transactions.
- Market risk: Mutual funds are subject to market risk, and fluctuations in market conditions can impact the value of the fund's underlying investments, leading to potential losses for investors.
- Overdiversification: While diversification is a key advantage of mutual funds, overdiversification can dilute returns and limit the potential for significant gains, especially in high-performing sectors or stocks.
- Tax implications: Mutual fund investments may be subject to capital gains tax, dividend distribution tax, and other taxes, depending on the type of fund and the investor's holding period, potentially reducing overall returns.
Understanding these pros and cons can help investors make informed decisions about whether mutual funds align with their investment goals, risk tolerance, and financial objectives.
What are shares?
Shares, also known as stocks or equities, represent ownership in a company. When you buy shares of a company, you become a partial owner and share in the company's profits and losses. The value of shares can fluctuate based on market conditions, the company's performance, and other external factors. Investing in shares can potentially yield higher returns, but it also comes with higher volatility and risk compared to some other investment options.
Pros and cons of stocks
- Potential for high returns: Stocks offer the potential for high returns over the long term, especially in growing companies or emerging sectors.
- Ownership stake: Investing in stocks provides shareholders with partial ownership of the company, entitling them to voting rights and a share of company profits through dividends.
- Liquidity: Stocks are highly liquid assets, allowing investors to buy and sell shares relatively quickly on public stock exchanges.
- Diversification opportunities: Investors can diversify their portfolios by investing in a variety of stocks across different industries, regions, and market capitalisations.
- Hedge against inflation: Stocks have historically provided a hedge against inflation, as companies can adjust prices for goods and services to reflect rising costs.
- Volatility: Stocks are subject to price fluctuations and market volatility, which can result in significant short-term losses and fluctuations in portfolio value.
- Risk of loss: Investing in stocks carries the risk of partial or total loss of invested capital, especially in the case of bankruptcy or poor company performance.
- Lack of control: Shareholders have limited control over company decisions and management actions, as major decisions are often made by company executives and boards of directors.
- Emotional investing: Stock market fluctuations and media hype can lead to emotional investing decisions, such as panic selling during market downturns or overconfidence during bull markets.
- Research and due diligence: Successful stock investing requires thorough research, analysis, and due diligence to identify quality companies, understand market trends, and make informed investment decisions.
Difference between mutual funds and shares/stocks
Managed by professional fund managers
Managed by the investor
Offers diversification across assets
Concentrated exposure to a single company
Generally lower risk due to diversification across assets
Higher risk due to specific concentration
Varies (Equity, Debt, Hybrid, etc.)
Investment in company's growth potential
Usually, higher liquidity
Liquidity depends on the trading volume