Mutual Funds vs Direct Investing: Differences, Pros, Cons, and Suitability

Investing in stocks is gaining more and more popularity as people wish to take advantage of the rising indices. There are two stock investing methods: investing directly in equities and investing through an asset management business.

We will now explain the differences between the two methods and help you make an informed choice.

Mutual Funds – Overview

Mutual funds are a type of investment product that pools the capital of several investors who share a common investment objective or goal. The fund managers, who are experts in this area, use the pooled capital to invest it in various asset classes, such as stocks, bonds, and commodities. The investor receives the return on their investment after their costs and fees are subtracted; the company responsible for this process is called an asset management company, or AMC.

Did you know?

As of January 2024, the mutual fund sector in India managed 52.74 lakh crores worth of assets. 

Types of Mutual Funds Based on Asset Class

There are different types of Mutual Funds based on the asset class.

1. Equity Mutual Fund – This mutual fund category invests predominantly in equity or shares; this category has more risk than other categories as they are sensitive to market fluctuations.

2. Debt Mutual Fund – The investors who invest in this category of mutual funds are relatively risk averse. Thus, their money is invested in fixed-income securities such as treasury bills, bonds, commercial papers, etc.

3. Hybrid Fund – This fund category is the combination of both equity and debt mutual funds. The portfolio of hybrid funds will have a specific allocation of equity to provide growth in your portfolio return and debt to provide stability and consistency.

Note – Mutual funds can be segregated into regular and direct funds, click here to check out our blog.

Pros of Investing in Mutual Funds

Diversification – The principal advantage of investing in mutual funds is their ability to diversify your investment portfolio, thus lowering the chance of loss over time. 

Liquidity – Because you can take your money out at any time, investing in mutual funds gives you the benefit of liquidity

Affordability – With just INR 100 at minimum, you can begin investing in mutual funds. Any investor can afford it. 

Professional Management – Your investment amount will be managed by professional fund managers who have a team of research analysts to identify investment opportunities.

Transparency – You can easily track your investment where your money will be invested and monitor the performance of it.

Cons of Investing in Mutual Funds

Expense Ratio – Mutual funds charge various costs for managing your investments, including administration and management fees, which will lower your return over time. 

Selection of funds – Numerous funds are available for market investment. Selecting the right fund is a task for the investor; sometimes, an investor gets confused among the funds and chooses the wrong fund.

Note – If you wish to know more about analysing mutual funds, check out our blog by clicking here.

Exit Load – This fee is charged by asset management companies from an investor when they redeem their fund before a stipulated period. If an investor wants to redeem their fund before the stated time, they will have to pay this fee to the fund management company.

Fund Manager – Performance may be impacted if investors place their savings in a mutual fund based on the fund management’s performance reports. Still, the fund manager is not skilled in picking stocks, which leads to reduced returns.

Direct Investing – Overview

When you invest directly into stocks through your demat account, it is known as direct investing. In this, you don’t have to go through any intermediary, such as an asset management company, and investors buy the company’s stocks independently after performing their due diligence.

A share or equity represents the ownership in a company, and by investing in this, the investor can participate in the company’s growth.

Did you know?

As per the data released from Central Depository Services and National Security Depository, the total demat accounts in India stands at 14.39 crore as of Jan 2024.

Pros of Direct Investing

Decision making – The investor has the full authority to decide in which stock they want to invest their money, and they can buy or sell the securities any time they want.

Cost-effective – Direct investment into stocks can save various costs that an investor will have to pay while investing through different intermediaries.

Higher returns – Investing directly in equities might yield a potentially large return for an investor in exchange for increased risk. 

Liquidity – A direct stock investment gives investors complete control over when and how much they can take from their investment without worrying about exit costs. 

Diversification – When making direct investments, an investor can effortlessly diversify their portfolio across several asset classes or sectors based on their requirements and risk tolerance. 

Cons of Direct Investing

Market Risk – Your portfolio valuations will suffer greatly from any market decline. Several factors, including adjustments to interest rates or corrections in the global market, can bring this about.

Concentrated Risk – Your risk will rise if you directly invest in individual securities because your portfolio will be concentrated into a limited number of stocks. 

Investor Bias – Multiple biases could cloud your thinking since you pick stocks independently. Multiple irrational biases come into play when we select stocks; all of them can dramatically affect your portfolio.  

Difference between Direct and Mutual Fund Investing

Risk – Since equities is among the riskiest asset classes, direct investing carries a higher risk than investing in mutual funds. 

Volatility – Compared to mutual funds, which include a diverse portfolio of equities to offset market volatility, investments in individual stocks possess more volatility.

Minimum Investment – Any group of investors can afford to invest in mutual funds, with a minimum amount of 100 INR. Conversely, investing directly in stocks requires a larger capital contribution because many stocks have higher pricing, making them unaffordable for most investors. 

Cost of investment – Investing in stocks directly incurs several fees, including brokerage from the broking company and various taxes (such as GST and security transaction taxes). Mutual funds also charge fees for services rendered, but are more than the fees charged while investing in stocks. 

Convenience – Mutual funds offer hassle-free investment. Once you are done with your investment, an asset management company will do the rest of the work, such as identifying the asset class, investing in securities, and monitoring the same. On the other hand, direct investment requires continuous monitoring by the investor.

Professional Management – To invest directly, one needs to have a strong skill set to identify the correct stock. However, while investing in a mutual fund, there is no such need to do it as these all will be done by the asset management company’s fund managers.

Suitability

The investor’s risk tolerance and desire will choose whether to choose mutual funds or make one of the direct investments. Mutual funds are the ideal investment product if you are just starting in the world of finance. However, if you are comfortable taking risks and are knowledgeable about financial concepts, direct investing is the better choice. 

Conclusion

In a nutshell, direct investments are best suited for individuals who possess knowledge about stock investing and want complete control over their investments, while mutual funds are best suited for those who lack the time to regularly monitor their portfolios. In conclusion, there is no right or wrong way to invest; the ultimate goal is to generate wealth and earn returns.

Choosing the best alternative among them is entirely dependent on your risk tolerance and investment objectives.

Frequently Asked Questions (FAQs)