“Invest early, go long.” “Start investing in shares.” Start with mutual funds.”
There is so much about financial planning we hear about… but how much are we aware of?
Stocks, bonds, real estate, gold, ETFs – investing can be often confusing for beginners with numerous instruments.
While they are all good for their purposes, you should know what works for you best. On a personal level, shares and mutual funds are quite popular. These are two instruments that are often considered very similar.
Both of these have different features which may appeal differently to different investors.
Let’s get started.
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A share represents a unit of equity (on an equal basis) ownership in a company. The company’s shareholders are entitled to profits and losses equally. Typically, a company issues shares to the public to raise capital.
The shares issued can be Equity or Preference.
i. Equity shares:
These are ordinary shares that are widely traded on the stock exchange. They are issued at a standard value and come with voting rights and substantial dividends.
ii. Preference shares:
These shares are given a preference over equity in the distribution of dividends and the event of liquidation. While these are considered financially more stable, they carry no voting rights.
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A mutual fund is a trust that collects money from various investors with a mutual goal. This fund is then invested in various stocks across industries. The combined holding, the portfolio, is invested in equities, bonds, gold, debt instruments, etc. The fund, managed by a professional fund manager, fetches the profits and losses to the investors.
Most mutual funds help gain higher returns and facilitate capital appreciation in the long term. Each investor holds units that represent a fixed portion of the holding. The profits are distributed proportionately among the investors based on the Net Asset Value of the units.
Mutual funds have three broad categories based on maturity and principal investment.
1. Open-ended scheme
2. Close-ended scheme
3. Interval scheme
Both shares and mutual funds are regulated by the Securities and Exchange Board of India (SEBI), making them transparent and reliable.
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Here’s how the two are different:
Shares are high-risk investments. They could give you super large profits or a tremendous loss too since the entire amount is invested in a single company.
Mutual funds have a lower risk of losses. The investments are diversified into multiple channels and managed by seasoned professionals.
There is a potential for large gains as well as large losses in investing in the shares of a company.
Mutual funds provide high to moderate returns based on the scheme. Where one of their investments may fetch higher returns, another may provide low returns – this is averaged out due to a diversified portfolio.
3. Control over investments
Investors must invest directly in the stock of a company through a Demat account and keep track of it personally.
However, unlike shares, mutual funds are managed by managers who are financial experts.
4. Investment tenure
Shares can be invested for the short term or the long term. One can earn large profits even in a day or two, or lose miserably.
However, most mutual funds reflect better results on long-term investments.
Shares are traded during normal trading hours and are more liquid than mutual funds.
Mutual funds are traded once a day when the markets close. You usually have to wait for a day to liquidate.
6. Knowledge requirements
To manage shares and invest effectively, the investors need to be well-versed with the market. A deep understanding of the market conditions helps make informed decisions.
None of this is required for investing in the case of mutual funds. Investors don’t have to be on their toes since the fund managers are doing the work for them. While market knowledge is not needed here, it rewards well in understanding different schemes and benefits.
7. Portfolio diversification
Investing in a single stock and diversifying is difficult. It is possible, though, to invest in various sectors directly and diversify. More diversification means less risk.
In mutual funds, there is a wider diversification, which makes them safer.
Investing in the shares of a company gets you ownership in the same to the extent of your investment.
In mutual funds, however, the investor is not the direct owner of the company. The fund houses managing these investments are the direct contributors to a company.
9. Systematic investment
If an investor wants to buy shares, it must be in lump sum. You can purchase the shares of the same company again but this is often sporadic.
Mutual funds, however, also provide a Systematic Investment Plan to instill discipline in investing.
The last word:
Both shares and mutual funds are excellent avenues for investment and have their own set of advantages and disadvantages.
The choice between the two falls upon the investor’s goals and strategy. Before diving into either of those, remember to factor in your income, risk appetite, and goals.