Do you suggest buying mutual funds or investing directly in stocks?

From my immediate family to everyone in the extended circle of my distant family friends, everyone has asked me this question at least once. While I have no stats on how many took my advice, my answer had one thing common in 100% of cases. It always started with this phrase – it is just ‘not possible to tailor a one-size-fits-all approach’ here.

Among the many factors which play a part in influencing such a decision, Investor’s Financial Goals and standing are particularly important.

Compare the circumstances of A& B, working at the same office and drawing identical salaries:

A: 26 year old single man who just started with his new job that pays Rs. 30,000/ per month.

B: 30 year old father of 2 young children earning a salary of Rs. 30,000/ per month.

The matter may get even more complicated depending upon the family wealth available to each of them.

Sophistication of Investor is another equally (if not more) important factor. For the curious and financially inclined, it may make more sense to construct a well diversified portfolio of assets; but if you are convinced that you do not have either the time or the will to undertake such a task, it’s advisable that you let an expert support your investments.

There are 2 primary reasons why people invest in Mutual Funds:

SAFETYthe element of ‘safety of investment’ comes from the fact that these funds are managed by expert fund managers whose primary job is to monitor your investments like a hawk. Fund managers spend a lot time researching and predicting the future of various asset classes for a fund management fee.

Keep in mind: Your returns will depend not just on how talented the fund manager is but also on where your funds ultimately get invested (I.e. stocks, bond, gold, commodities or a hybrid mix of all assets). From time to time, fund houses roll out plans to invest in different asset classes based on where the outlook looks most promising. For this reason there is some bit of herding in the mutual funds space. This is why when one falls, they all fall! Then, the crash happens.

Also Read: Different Types of Mutual Funds

Nevertheless, empirical evidence suggests that professionally managed funds over a period of time almost always outperform the broader index. At the same time, it is also true that if you construct your own portfolio of ‘reasonably well researched stocks’ and invest for long term, you are likely to beat most professionally managed funds.

Hassle Free: this is where mutual funds, especially via Systematic Investment Plans (SIPs) score the biggest advantage over investing directly in stocks. As a businessman or as a busy working professional, I don’t expect you to read anything beyond this article in order to try and make a portfolio of stocks or decide which mutual fund to buy. Most people choose mutual funds as an easy way to invest money in a relatively safe asset class which grows at a rate higher than bank deposits. There certainly is merit in doing this. Over a period of time, compounding will give you higher returns than what you can imagine, even somewhat wildly, in the short to medium term.

For me, the key take away from this poll was that 80% of those who participated believe that Mutual Funds will give you returns in excess of 10%. Given that these returns are tax free in the long term (for equity funds), it is astonishing that people still choose fixed deposit investments that pay under 6.5% (post tax) for multi year investments.

*The poll was conducted on my twitter handle @sanasecurities. My followers are pre-dominantly those interested in stocks and financial products.

One more reason why it may be advisable to invest in mutual funds has more to do with human behavior than anything else. Look at the results of the poll below:

There is more to the above poll than meets the eye. Mutual funds may actually be MORE HELPFUL TO THE 78% than to those who sell and leave. Here is a lesson in behavioral finance: MENTAL ACCOUNTING BIAS: Investors are much more distressed by prospective losses than they are happy by equivalent gains. Investors typically consider the loss of Rs. 100 twice as painful as the pleasure received from a Rs. 100 gain.

Loss aversion or mental accounting is a problem related to human psyche and plays out not only in stocks but in all sorts of asset classes.

Ill leave you with this thought – I know someone who bought a house for investment in 2010 for Rs. 5.5 Cr. and sold it in 2015 for Rs. 4.9 Cr. He has absolutely no pressing need for cash. He may just be a smart businessman.

Related Post: Psychological Traits of A Successful Stock Investor