The number of mutual fund holdings has also gone up though data do not indicate an exponential rise in the same. Numbers do not show any correlation between demat account and mutual fund portfolio numbers though behavioural analysis suggests that new-age investors tend to leapfrog into stock investments without paying any heed to mutual fund investments.
Many stock market investors, especially, those looking to make quick money from the market volatility tend to question the validity of earning by investing in mutual funds. The rationale behind including mutual funds or a mutual fund portfolio in financial planning has been questioned by many with existing investments in stocks for wealth creation.
Hiren Thakkar, Chartered Accountant Proprietor, Hiren S Thakkar & Associates, said, “Whether one should go for direct equity or mutual funds is a personal choice, but for risk management perspective- direct equity investing requires in-depth analysis and research to earn sizeable returns, On the flip side, mutual funds require lesser analysis comparatively. I think one should start with mutual funds and then explore direct equity investing subject to knowledge of fundamental analysis and the nitty-gritty of sectors and businesses. To be a successful stock market investor, one must have ample time to read annual reports and other materials.”
Suresh Sadagopan, Founder, Ladder7 Financial Advisories shared, “We generally suggest managed funds only, mutual fund schemes being one of the products we suggest. We seldom suggest direct equity investments.”
Given the limited awareness of the intricacies of stock market investing among most individuals, it might be more beneficial to establish mutual funds as the cornerstone of your portfolio, with stocks serving as supplementary components, though a lot depends on how investors plan and visualize their wealth creation strategies.
Mutual fund vs stock market investing
Achieving success as self-reliant stock investors requires the ability to independently conduct research and comprehend the companies in which they are investing. This entails studying financial statements, perusing news articles, and analysing analyst reports. It also involves diligently monitoring the stock market on a daily basis.
Modern-day investors prioritise career development and skill enhancement in their chosen professions, aiming to make a significant impact at work. Engaging in direct stock investing at this juncture of life may act as a significant diversion from one’s professional commitments, as delving into equity research demands substantial study and constant market monitoring.
Investing in mutual funds is not a cakewalk, especially, for those unaware of their risk appetite or how to formulate their financial goals. Also, asset management companies (AMCs) come out with new fund offers in separate categories, making it more confusing
Commencing systematic investment plans (SIPs) with equity funds, including index funds, can offer you a solid introduction to the world of equities, all while avoiding the distractions and stress associated with direct stock investing.
To start with, SIPs entail investing a fixed sum of money at regular intervals in a mutual fund scheme. This approach proves advantageous for equity investments since it allows you to spread out the cost of your investment over time. Index funds, which are a category of mutual funds that mirror specific market indices like the S&P 500, present an effective means to participate in the stock market without the need to select individual stocks.
The best way out is to approach financial advisors who can advise on the right way to invest money. Also, once you have spent at least five years in the market, witnessed several cycles, and understood the nuances of picking stocks and investing in them, you should consider stock investing as one of the means to grow your money.
Meeting financial goals
Are you aware of your short-term and long-term financial goals? Do you think that the stock market can help achieve them, especially, as and when you need money? What if stock prices dive deep during continued bear runs when you want to extract your money from the market?
Many people invest in the stock market with the hope of becoming rich overnight, but does the market always reciprocate with similar gusto? The risk factor is inherent and inescapable, which means that you always run the risk of losing your capital. Investing directly in individual stocks may not be the ideal choice for achieving specific goals within the next few years. The stock market’s inherent volatility can lead to periods of decline, posing a risk that your direct stock investments may underperform precisely when you need to access your funds to meet your time-bound goals.
Harbouring realistic goals while investing in the stock market is imperative. Instant millionaire status is unlikely, but with prudent, long-term investments, you can steadily grow your wealth and attain your financial objectives.
Investing in a mutual fund portfolio offers an excellent means to work towards specific financial objectives. Below, you’ll find some overarching recommendations for selecting the most suitable mutual fund categories based on your various investment timeframes:
- Within a five-year timeframe: Consider opting for debt mutual funds to pursue short-term objectives. They boast a relatively low-risk profile and deliver consistent returns.
- For a five-to-seven-year horizon: Hybrid mutual funds can prove advantageous for medium-term goals. They blend equity and debt elements, striking a balance between growth potential and risk mitigation.
- Stretching beyond seven years: Equity mutual funds stand out as the prime choice for long-term aspirations. These funds possess the capacity to yield superior returns compared to other asset classes over extended durations.
Below, you’ll find some illustrations of mutual funds suitable for various investment timelines:
Within a five-year period
- Liquid debt funds
- Short-term debt funds
- Ultra short-term debt funds
- Overnight funds
For a five-to-seven-year horizon
- Balanced hybrid funds
- Equity hybrid funds
- Multi-asset funds
Extending beyond seven years
- Large-cap equity funds
- Mid-cap equity funds
- Small-cap equity funds
- Flexi-cap equity funds
Opting for a combination of diverse mutual funds to craft a well-rounded portfolio is another viable approach. Such diversification serves to mitigate your overall risk and enhances the likelihood of achieving your financial objectives.
Why are mutual fund investments better?
Equity funds are under the expert management of professionals equipped with the necessary expertise and resources to monitor markets and handle risk on your behalf. They employ a range of strategies, including position-sizing, risk control tools, and diversification, to optimize returns while mitigating risk.
It’s a common practice for professional portfolio managers and accomplished equity investors to uphold personal mutual fund portfolios. Several factors contribute to this practice:
- Diversification: Mutual funds offer a straightforward and effortless means to spread your investments across a spectrum of stocks and sectors. This, in turn, can effectively curtail your overall risk exposure and enhance the likelihood of attaining your financial objectives.
- Professional management: Mutual funds are under the stewardship of seasoned professionals equipped with the acumen and resources necessary for researching and selecting investments on your behalf. This professional oversight proves invaluable, especially for investors who may lack the time or expertise to manage their own portfolios.
- Convenience: Investing in mutual funds is a hassle-free option. You have the flexibility to purchase or sell mutual fund shares online or through a brokerage. Additionally, you can establish automatic investment plans to consistently allocate a predetermined amount of funds each month.
Investing in mutual funds comes with certain inherent risks. They can exhibit short-term volatility and may not consistently meet performance expectations. Nonetheless, historical data indicates that over the long run, mutual funds have generally outperformed alternative investment options like certificates of deposits and savings accounts.
If you’re contemplating mutual fund investments, conducting thorough research is paramount. Opt for funds with a commendable track record and expert fund managers at the helm. Additionally, it’s essential to align your investment choices with your specific financial objectives and risk tolerance.
Choosing a disciplined investment style
Do you know why stock market investors lose their money? They invest in equities when the market is on a roll and fear entering the market when the market is in deep red. This is in stark contrast to what adept market investors do. They understand that bear markets present prime opportunities for long-term stock investments. This is due to the fact that stock prices tend to be lower during bear markets, allowing you to acquire more shares for your investment. As the stock market eventually rebounds, you stand to benefit from the subsequent rise in stock prices.
This also explains why investing through mutual funds serves one’s economic interests better. Equity mutual funds provide a structured approach to help you remain steadfast in your investment journey through SIPs. Although some individuals choose to pursue SIPs in individual stocks, committing to SIPs in mutual fund investments without fixating on short-term market fluctuations can open the path to superior long-term returns.
Engaging in the market via mutual fund SIPs represents an excellent method for harnessing the potential of compounding. Compounding occurs when your earnings begin to generate additional earnings, ultimately fostering substantial wealth accumulation over extended time horizons.
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Effective asset allocation
You cannot start your investments unless you know why and where you want to invest. Asset allocation stands as one of the foremost determinants of your long-term portfolio returns. It involves the strategic distribution of your investment portfolio across various asset classes. The objective of asset allocation is to mitigate risk while optimizing returns. The most suitable asset allocation for you will be contingent on your unique circumstances, including your risk tolerance, investment horizon, and financial objectives.
For example, risk-averse investors will choose fewer equities and more debt instruments like fixed deposits and sovereign savings schemes in their investment portfolios. For individuals in their youth with a lengthy investment horizon, there might be room to accommodate greater risk by allocating a larger portion of their portfolio to equities. Nevertheless, as one’s age advances and the investment horizon shrinks, a prudent strategy may involve decreasing risk exposure by directing a larger share of the portfolio into debt and cash assets.
Instead of going through the rigmarole of choosing stocks, savings schemes, and bank deposits, you may opt for a simple scheme of putting money in mutual funds. Open-end mutual funds serve as an excellent method for establishing a customized asset allocation strategy. Within this framework, you have the flexibility to select from a range of equity funds, debt funds, and international equity funds, allowing you to tailor a portfolio that aligns with your specific requirements and risk tolerance.
Furthermore, open-end mutual funds provide the advantage of on-demand liquidity, enabling you to purchase or sell mutual fund units at any point. This feature simplifies the process of rebalancing your portfolio whenever necessary.
After formulating your asset allocation strategy, the next step involves selecting the appropriate mutual funds for each asset class. For instance, when investing in equities, it’s advisable to consider a combination of large-cap funds, small-cap funds, and international funds. On the other hand, when delving into debt investments, a diversified approach could involve a mix of government bonds and corporate bonds.
Efficient tax management
For those who invest directly in stocks, capital gains tax assumes significant importance. Capital gains tax is a tax imposed on the profits accrued from selling an asset, such as stocks. The applicable capital gains tax rate hinges on the duration for which you held the asset before its sale. If your ownership period is less than one year, you’ll be subject to short-term capital gains tax, which is equivalent to your regular income tax rate. In contrast, if you held the asset for one year or more, you’ll be liable for long-term capital gains tax, which is typically lower than the short-term capital gains tax rate. For those who engage in frequent trading, the potential capital gains tax liability is a crucial factor to bear in mind.
Under Indian tax regulations, mutual funds are regarded as pass-through entities. This implies that the capital gains or losses generated by the mutual fund are distributed to unitholders in accordance with their respective investments. This arrangement can be highly advantageous for investors, as it enables them to enjoy the tax-efficient advantages of the rebalancing and stock replacement techniques employed by mutual fund managers, all while avoiding the need to pay capital gains tax for each individual transaction.
For instance, if a mutual fund manager sells a stock that has increased in value, the resulting capital gain is passed on to the unitholders. However, as long as the unitholders maintain their investment in the mutual fund, they are exempt from paying capital gains tax on this profit. This is because capital gains tax is only applicable when the unitholders decide to sell their mutual fund units.
This tax-efficient structure offers a substantial advantage for long-term investors. By investing in mutual funds, individuals can access the expertise of professional fund managers and leverage their tax-efficient rebalancing and stock replacement strategies, all without being burdened by concerns about the impact of capital gains tax on their returns.
The debate between stock market investing versus mutual fund investing is never-ending and depends on myriad factors. However, considering how regular market ups and downs have caused many new investors to lose their hard-earned money in the stock market, it would help if they start their investment journey with mutual funds and then gradually move on to stocks after realizing which companies and their shares are worth their risk, money and time.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.
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Updated: 19 Oct 2023, 09:02 AM IST