Why you should choose mutual fund over individual stock

Whenever investing is talked about, you would probably hear stories about how much the stock of Wipro or Infosys has risen since their inception. You might also get to hear that if you would have bought shares of Eicher Motors instead of buying a Bullet, or shares of Page Industries instead of Jockey products, you would have made a lot of money. However, have you actually seen people make this kind of money? Are these stories fake? Not at all! What you need to think about is that the time to invest in these stocks was different. Did you have the time or money to do that investment in the past? Was your risk profile suitable for such an investment at that time?

In addition to this, these are just success stories that you hear. You have also heard of Jet Airways, Kingfisher, Satyam, etc. as the other side of the coin.

You cannot predict the future, so at the time of investing, you would not know whether the stock that you are investing in is going to provide great returns in the future or crash and make you lose your hard-earned money. If you wish to invest in the stock market, you should do so only if you tick the following three boxes:

1) You have around Rs 25 lakh to invest in the stock market which is not more than 5 percent of your net worth. Though there is no fix formula for this but the logic is to withstand any major loss in your stock investments and restricting it to 5 percent of your total net worth in the initial phase of your stock market investment will make you handle any negative situation without losing your sleep.

2) You have enough time to do your research and understand the stock market.

3) You have enough experience to be able to know when to buy and sell in the stock market.

It might not be so that everyone can tick these three boxes. However, this does not mean that equity investment is out of the picture. If you want to go in the stock market, then you can start off with blue-chip stocks. Most of these companies are too big to fail, so it is hard to go wrong here. You can diversify to mitigate your losses here too, in case even a blue chip company fails. The strategy to employ here is that you buy these stocks, and your children will sell it. The point is to invest for the long term, following the principle of buying a stock, not renting a stock, as said by John Bogle, former CEO of the Vanguard Group.

Looking beyond blue chip stocks, investing in small-cap or mid-cap companies through stocks is very difficult. Regular tracking, and knowing how much and when to buy or sell is difficult when you are not doing this full time. Mid-cap and small-cap shares can help you make a lot of money, but you may also lose a lot of money if you don’t play your cards well. This is where mutual funds can come to your rescue to help you make money from this sector with a reduced element of risk.

Diversification is built into mutual funds by default. They can invest in different securities by aggregating the money of a pool of investors. Mutual fund investment is professionally managed by a fund manager on behalf of the investors, where each investor holds a particular share of the entire portfolio and is a participant in any losses or gains of the fund. The fund’s portfolio is structured to match the objectives stated in the prospectus.

Since a mutual fund manager has access to market information and manages funds professionally, it is of great benefit to smaller investors. Mutual Funds can trade cost-effectively and help to mitigate risk because of the number of stocks they invest in. Even if one or more stocks tumble, other stocks can help to cover up for that loss.

Mutual funds also give access to the equity market at a lower price, for as low as Rs 500 per month, where you can gradually build up your corpus by increasing your investment and investing slowly but steadily.

You should go ahead and invest in the stock market only once you have a sizeable chunk of investments ready in mutual funds. If your expectation of returns from the equity market is 12-13 percent, then mutual funds are the way to go.

Keep in mind that you can lose money even in mutual funds if you have the wrong strategy, or choose the wrong schemes to invest in. Going with multi-cap or index funds is a safe and easy choice for those looking to start off with mutual fund investment.

Read his columns here.