Stocks Or Equity Funds: Which One Is Better?

Hemant Rustagi
Chief Executive Officer, Wiseinvest Advisors 

Mutual funds help investors create the right balance between risk and reward. They also improve the tax efficiency of returns despite the tax rules being the same irrespective of the medium of investment.

Equity, as an asset class, has proved its potential as a wealth creator for investors. However, considering the attendant risk of volatility, one must choose the right option to get the best out of equity investments.No wonder, investors often face the dilemma of whether to invest directly into the stocks or take the mutual fund route. In the last few months, the number of investors investing directly into stocks has increased significantly. The question being asked is whether they are finding investing directly into the stock market more productive than a proven efficient investment vehicle like mutual funds.

While it is good to see increased participation from investors in the stock market, it will be premature to conclude that stocks can be more beneficial for investors in the long run. Every investor must remember that investing in equities is one thing and getting the best out of them is another. While direct investment into stocks can be potentially better as one can take concentrated bets, the level of success will depend upon one’s ability to select the right stocks and knowing when to enter and exit out of a stock.

As the stock prices move in anticipation of the future events as well as to reflect the current events, considerable research has to be carried out trying to forecast the performance of the economy, industries and the companies. If one is not familiar with this, it can be quite a daunting task to do so. On the other hand, mutual funds can be an ideal way of investing in equities especially for those who don’t have the wherewithal and expertise to invest directly. Apart from getting a diversified portfolio, an equity fund investor also benefits from the expertise of professional fund managers who invest money as per the mandate given to them.

Simply put, mutual funds help investors create the right balance between risk and reward. Moreover, mutual funds also improve the tax efficiency of returns despite the tax rules being the same irrespective of the medium of investment. For example, if you decide to sell a stock within a year, short-term capital gains tax will be taxed at 15 percent. However, when a fund manager sells a stock within a year, there is no tax liability for the fund as well as for you as tax incidence applies only when you decide to redeem your holdings in a fund. Simply put, if you decide to redeem units after a year, long-term capital gains will be taxed at 10 percent.

Similarly, any dividend from a company and a mutual fund scheme is taxable in the hands of investors at the applicable tax rates. However, when a mutual fund scheme receives dividend, there is no tax liability for the fund. Therefore, if you opt for growth option, this divided gets passed on to you as capital gains and that improves your post-tax returns if you are liable to pay tax at a higher rate. While there are pros and cons of investing through both these mediums, mutual funds have an edge especially for the not-so-experienced investors.

Of course, a combination of stocks and equity funds can be ideal once an investor gains experience and starts understanding the nuances of equity investing. The stock portfolio allows investors to benefit from the growth potential of select companies while mutual funds can supplement it by allowing diversification within a sector, segment and investment philosophies like contra and value investing. Similarly, a sector fund can not only be a perfect substitute for buying a few stocks from a sector that one likes but also takes some of the risk out of taking a concentrated bet.