If you are wondering whether mutual funds are better than direct stock investing, keep reading.
You know that mutual funds invest in equity directly. But often times you hear rags-to-riches stories that so-and-so investor made tons of money by betting on one select stock. These success stories often tempt you into thinking that direct investing is better than investing in equity mutual funds. But wait, is it really?
NOT ALL ASSETS HAVE THE SAME RETURN POTENTIAL
There are inherent advantages of each technique i.e. going solo or investing through mutual funds. Normally, you rank the potential returns from each strategy. Usually, bonds fetch lower returns than mutual funds, and mutual funds lower than direct equities. The risks in bonds is lower than mutual funds.
Likewise, in mutual funds the potential for returns is lower than direct equities because funds tend to have a lower risk profile, and practice diversification.
Depending on where you invest in the market, the potential for returns depends on each segment and the underlying asset class and the potential for loss in those assets. For instance, mid-cap stocks can provide the greatest returns, but this segment is also the most perilous because you could lose the proverbial shirt, and at the moment mid-caps are getting chewed (read what should you do in mid-caps) in a market carnage.
DIRECT STOCKS HAVE ADVANTAGES AND DISADVANTAGES
If you are used to investing in mutual funds, understand that individual stock investing has a greater return potential, simply because an investor is taking a greater risk in this investment. First, you don’t know how a stock is going to perform because there are several factors that influence a stock price.
Understand that the value of a stock may involve many more factors than its stock price. So, a stock might not do well simply because it seems to be lowly priced.
But there are several factors like sentiments towards the sector, growth potential of the company, quality of earnings reported by the management, and the understanding of the business by market participants.
MUTUAL FUNDS PROVIDE AUTOMATIC DIVERSIFCATION
So, you got to make a decision on how you want to assess the stock market. If you are a do-it-yourself investor and want to invest in the stock markets directly, then you ought to know that the potential for loss is as great as the potential for high rewards. Direct investing is more sensitive to market sentiments.
On the flipside, mutual funds are a good option that provide automatic portfolio diversification. When you buy mutual funds, you are automatically buying a large diversified portfolio of equities rather as against a single stock.
Diversification is key when you want a stable portfolio, and so if you do not have a first-hand long enough experience of navigating the perilous equity markets, then mutual funds should be your first choice of investments.
The downside is that while you may make lower returns than direct investing, but the upside: you have a well-diversified portfolio.
