Should You Shift from Mutual Funds to Invest Directly in Stocks?
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Amid the equity market crash due to the pandemic and the resultant lockdown, equity mutual fund inflows witnessed a downward trend. Interestingly, over the same period, there was a spike in the number of new trading accounts, which indicated that direct equity investment through stocks has emerged as a new preferred mode.
Even though the market has risen considerably from its lows of March, the recovery in mutual funds returns has not been on par. The 5-year return of many equity funds is still around mid-single digit. Meanwhile, if you had invested in select individual stocks over this period, your returns would have been anywhere around 15-30% CAGR or even more.
For example, Reliance Industries share generated returns of 36% CAGR in the last five years; HDFC Bank and Infosys share grew at 15% and 11% CAGR, respectively over the same period. This, probably, made you wonder if you would be better off investing in stocks rather than equity, bringing us to the critical question...
Does this mean you should shift your investment from mutual funds to invest directly in equities?
A handful of stocks drive the market; so if you were holding these stocks in direct equity, it would have generated better returns since March compared to mutual funds that were invested in a diversified portfolio of 40-50 stocks.
However, once the rally in these stocks runs out of fuel or starts to underperform, the returns may become range-bound or even decline. Whereas mutual funds, through active management and expertise in identifying the growth potential of stocks/sectors, can quickly spot potential winners. A well-diversified portfolio of mutual funds can help limit the downside risk better than a portfolio containing a handful of stocks.
[Read: Do You Own Equity Mutual Funds That Have Underperformed Their Benchmark? Read This!]
photo created by jannoon028 - www.freepik.com
It would imprudent to compare the performance of a mutual fund after a deep correction in the market and ignore the bigger picture. It is about how your portfolio performs over different market phases (both the ups and downs) and not just the near term performance.
It is important to hold a portfolio with a diversified set of stocks, sectors, market capitalisation, asset classes, and investment-style to minimize the risk. Mutual funds managers actively track the companies/sectors to identify the growth potential based on various aspects. They are also quick to identify red flags and developments such as legal/technology/taxation and other related changes that may affect a stock/sector which helps to take necessary action to protect the portfolio.
However, for the common investors, it may not always be easy to get hold of such information before fund managers. Besides, not many have the time and/or expertise to manage an equity portfolio, which is where mutual fund comes to the rescue.
If you are worried about mutual funds generating lower returns, the following example can help you regain confidence:
During the 2008 financial crisis, the equity market had witnessed a similar crash. The 5-year mutual funds SIP returns were poor, in some cases in the negative territory. But, investors who continued with their investments were rewarded by terrific gains the next year.
Table: Impact of global financial crisis on mutual fund returns and the subsequent recovery
For illustrative purpose only
(Source: ACE MF, PersonalFN Research)
Here are some other advantages of choosing mutual funds over stocks:
In addition to diversification across stocks and sectors, mutual funds give you the advantage of investment in other asset classes such as debt and gold. You can choose from different styles of investment viz. growth or value style or a blend of both, or management style such as active or passive. Certain mutual fund categories act as an efficient tax-saving instrument.
Moreover, mutual fund investments can help you eliminate various biases. Investment in direct equities is often driven by biases such as emotion, herd mentality, anchoring bias, etc., which can cause you to deviate from logic and reason while making buy/sell decisions.
Remember that you can customize mutual fund investments to suit your needs, so you need not worry about short-term fluctuations in the market and you can trust the fund managers to make informed decisions devoid of such biases. As the investor, all you have to do is select suitable mutual fund schemes for your portfolio.
Another advantage of mutual fund is the low cost of investment. A stock price may range from a few hundreds to few thousands And you have to buy multiple shares of different companies to get the maximum benefit. Your total investment can, therefore, run up to a few lakh Rupees, with stocks of very few companies in hand. On the other hand, mutual funds allow you to start investing in a diversified portfolio of stocks with an investment of as low as Rs 500.
Investing in mutual funds through the SIP mode helps in adopting a disciplined approach towards investment, which ultimately can lead you to accomplish the envisioned financial goal. The rupee-cost averaging feature of SIP enables you to buy more units when the prices are low and fewer units when the prices are high. This way it helps you mitigate the risk of high volatility while you endeavour to compound wealth over the long-term.
So if you are holding worthy diversified equity schemes in your portfolio based on your personalized asset allocation, and if you have a long term investment horizon, you need to be patient about the short-term underperformance. It would potentially generate better rates over the medium to long term through smart stock/sector selection strategy.
At PersonalFN, we select mutual funds on the basis of 5 variable tests, viz. Systems and Process, Market cycle performance, Asset management style, Risk-reward ratios, and Performance Track Record.
| S |
M |
A |
R |
T |
| Systems and Processes |
Market Cycle Performance |
Asset Management Style |
Risk-Reward Ratios |
Performance Track Record |
PersonalFN recommends funds after it has gone through our stringent selection process and tested on these five essential parameters.
Here are some stringent qualification parameters that our expert research team looks at before recommending any fund:
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The fund manager possesses decent experience and is not overloaded with multiple schemes. Moreover, the fund house should have well-defined investment systems and processes in place.
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The fund has successfully generated positive returns across market cycles, viz. bullish and bearish. It is important the fund has the ability to limit your losses during a crisis.
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The portfolio should not be too concentrated, highly churned, or low quality. It should be managed efficiently.
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The fund must offer adequate return for the risk incurred. It should not be putting your money to unnecessary risk.
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The track record of the fund in terms of generating return on investment over various time periods, i.e. 1 year, 3 years, 5 years, and so on.
This matrix was specially developed by the in-house research team at PersonalFN. We believe it's probably one of the best and most reliable fund selection methodologies in the industry today.
If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.
Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.
PersonalFN recommendations go through our stringent process that assess both quantitative and qualitative parameters (as mentioned above before), providing you with Buy, Hold, and Sell recommendations on equity and debt mutual fund schemes.
If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!
Warm Regards,
Divya Grover
Research Analyst
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