The post-COVID rally has made a lot of investors multiply their wealth in a very short period. Everybody has an acquaintance either in their offices, friends, family or neighborhood who says they have made good to great money in the stock market in this period. For people who only invest in Mutual Funds or do not invest in equity at all, they definitely are feeling missed out. To add more misery to the FOMO (fear of missing out) feeling, conversations that say I bought this stock for X and it is 6X in a few months are prompting people to open a demat account overnight and start investing.
However, a lot of people are on the fence, since still they do not know which stocks to buy even if they want to invest directly. Most people want to piggy back on tips they get from their acquaintances to invest directly. Is this a wise thing to do or better to invest directly in Mutual Funds?
To put a very simple answer to this, for people who do not understand how the stock market works it is best to go through the Mutual Fund route. The reasons being:
1) Mutual Funds are managed by experts who understand the in and out of the companies they are investing in. They are much more likely to make informed decisions and generate better returns and manage the risks associated with it.
2) The lure of making 5x, 6x, 10x returns your friends and acquaintances have made is not the complete picture. You may hear about their wins, but may have not heard about the losses. What you need to know is what returns have they made on their overall portfolio and not just in 1 or 2 stocks which turned multibaggers and then compare it with returns of mutual funds. The biggest problem that arises here is that nobody tracks overall portfolio returns in stocks. Most platforms give the annual returns / CAGR / IRR for Mutual Funds but rarely is this data available for an entire stock portfolio; hence comparison becomes difficult.
3) By investing directly in stocks, you are eventually creating a portfolio. Lot of experienced fund managers are finding it difficult to beat benchmark indices, so what is the chance of you beating it based on tips of your acquaintances or half baked research?
4) In a bull market, you will get tips for buying stocks everyday. Not all tips will go on to be multibaggers, so on what basis will you decide which tip to bet on? Basically it will just boil down to your luck. And since you are inexperienced a few sessions in the red or lower circuits in your stocks will make you panic and sell.
5) Mutual Funds are generally not redeemed in the short term, hence you will end up paying long term tax rate @ 10% that too above INR 1 lakh annual profit. In stocks, if you are on tips and end up buying and selling a lot, it will lead to transaction costs and also short term gains which are taxed at 15%. Factoring in taxation and transaction cost is also important to arrive at overall returns for comparison purpose.
6) Direct investing is not for the faint hearted. When we invest in Mutual Funds, nobody looks at their portfolio on a daily basis. In fact a lot of people do not even look at it on a quarterly basis. This means when on a particular day the markets have crashed due to any global event, a mutual fund investor may not even know the impact it had on his portfolio. Whereas, when you invest directly in stocks, most people end up looking at it everyday, and not everybody would be comfortable seeing a day where their stocks have hit the lower circuit of 10% or 20%. In short, inexperienced investors are much more likely to hit the panic button when investing directly in stocks compared to a mutual fund portfolio.
It is better to understand the fundamentals of a company and functioning of the markets before taking direct equity exposure in companies, until then a mutual fund offer a safer way to access the stock markets for new and inexperienced investors.
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