Everyone of us dreams to be wealthy and constantly looks out for opportunities & avenues to grow money. Investing in Indian equity markets has delivered superior long term returns compared to other traditional options like Fixed Deposits, Recurring Deposits or Gold and better liquidity compared to real estate investments. Equity is inevitable for any kind of a long-term investment when you look at real, inflation-adjusted, post-tax returns. Many of us agree that the risk-reward ratio is highly inclined towards equity investments. We have to realize that what looks like freedom from risk in investments is actually freedom to become poor and this conclusion is unavoidable.
With growing interest in equities from retail investors, who now realize that investing in equities might help them generate inflation beating returns over the long-term. There are two ways to invest in equities for retail investors:
- Either directly purchase stocks of listed companies through a stock market broker
- Indirectly hold equities by investing in an equity mutual fund
What is an Equity Mutual Fund?
Equity mutual fund is a basket of stocks managed by professional fund managers, who invest in a large and diversified pool of equity stocks. As an investor, we can invest the desired amount to buy mutual fund units , and let the fund managers do the job. Following are few factors to dive into to get better understanding:
- Instant and affordable diversification: It is important to manage the risks associated with equities by diversifying. Mutual funds are well diversified as they hold a large number of equities (Generally 20+) and this is possible even with small amount of Rs.500. Compared to equity mutual funds, constructing a diversified portfolio through direct equities takes significant more work (identify multiple equities which will help diversify, buy equities of each company) and money (to buy the minimum number of equities of each company).
- Active portfolio management: This is an important factor in successful equity investment. Equity mutual funds employ professional fund managers who actively manage the fund by continuously monitoring the markets and take informed decision related to identifying, buying, holding, selling equities and most importantly practicing robust risk management techniques. But in case investor chooses to invest in equities directly, he/she need to spend significant amount of time and money.
- Ownership & Flexibility: You won't get the ownership of underlying stocks nor have flexibility to decide which stocks to buy/sell when invested through equity mutual funds, as you get when you buy the stocks directly.
- Tax Benefits: When an investor invests directly in stocks, there might be situation where he/she has to sell stocks within one year. In that case investor has to pay 15% short-term capital gains tax. In case of equity mutual fund, there is no capital gains tax on stocks sold by the fund. This will add up to significant benefits for you as an investor in that fund. Of course, one must hold one's equity fund for a year or longer to avoid short-term capital gains tax on the investment and Exit Fee (If Any).
Both of these options have their pros and cons, and investor have to decide what is the right choice depending on their specific needs. The choice between the two models of investing in equities depends on investor's risk taking capability, market understanding, time to do extensive research and defining and practicing risk management. Investors getting started or with limited time to monitor investments should invest through equity mutual funds as they provide multiple advantages as mentioned above.
Note: I don't mean to say that an individual investor can't invest in stocks/shares directly. I personally know few people who manage their investments themselves. Out of every 100 who try investing directly, perhaps 5 might be successful.