New investors are often faced with 2 options as far as investing in equity is concerned. Whether they should invest in mutual funds or directly in shares? For new investors, benefits of investing in mutual funds outweigh the benefits of investing in shares. In this blog we will discuss the 7 key benefits of investing in Mutual Funds versus directly in shares.
Risk Diversification: Mutual funds help investors diversify their risks by investing in a fairly diversified portfolio of stocks across different sectors. A diversified portfolio reduces risks associated with individual stocks or specific sectors. If an equity investor were to create a well diversified portfolio by directly investing in stocks it would require a large capital outlay. On the other hand mutual fund investors can buy units of a diversified equity fund with an investment of as low as
र 5,000/- only (even lower – र 500/- for ELSS funds). Further mutual funds are managed by professional fund managers who are experts in picking the right stocks to get the best risk adjusted returns. Retail investors often lack this expertise.
Economies of scale in transaction costs: Since mutual funds buy and sell securities in large volumes transaction costs on a per unit basis is much lower than buying or selling stocks directly.
Tax efficiency: Mutual funds are more tax efficient than most other investment products. Long term capital gains (holding period of more than 1 year) for equity mutual funds are tax exempt. Further dividends of equity funds are also tax free. For debt funds long term capital gain (holding period of more than 3 years) is taxed at 20% with indexation. Once indexation (due to inflation) is factored in the long term, capital gains tax is reduced considerably, especially for investors in the higher tax bracket.
High Liquidity: Open ended mutual funds are more liquid than many other investment products like shares, debentures and variety of deposit products (excluding bank fixed deposits). Investors can redeem their units fully or partially at any time in open ended funds. Moreover, the procedure of redemption is standardized across all mutual funds.
Variety of products: Mutual funds offer investors a variety of products to suit their risk profiles and investment objectives. Apart from equity funds, there are also income funds, balanced funds, monthly income plans and liquid funds to suit different investment requirements.
Variety of modes of investments: Mutual funds also offer investors flexibility in terms of modes of investment and withdrawal. Investors can opt for different investment modes like lump sum (or one time), systematic investment plans (SIPs), systematic transfer plans (from other mutual fund schemes) or switching from one scheme to another.
Disciplined investing: Share prices are highly volatile and can induce the investor to buy or sell in short time periods. This practise, more often than not, leads the investor to incur losses. Mutual funds encourage investors to invest over a long time horizon, which is essential to creating wealth. Furthermore, systematic investment plans encourage investors to invest in a disciplined manner to meet their long term financial objectives. Many investors fail to build a substantial investment corpus because they are not able to invest in a disciplined way. Savings not invested regularly often gets spent on discretionary lifestyle related expenses. Systematic Investment Plans (SIPs) in mutual funds help investors to maintain a disciplined approach to savings and investment. SIPs also help investors take emotions out of the investment process. Very often investors get very enthusiastic in bull market conditions, but get nervous in bear markets. It is an established fact that investments made in bear markets help investors get high returns in the long term. By investing through SIPs in a mechanical way, investors can stay disciplined, which is critical to achieving their financial objectives.
In this blog we have discussed the key benefits of investing in mutual funds versus directly in shares. While investing directly in shares definitely has its own advantages, the benefits of investing in mutual funds outweigh that of investing directly in shares, especially for new investors. If you have expertise in picking stocks at the right valuation, you can invest directly in shares. However, if you lack the expertise then investing in mutual fund is definitely a much better option.