How Is Investing In Stocks Different From Mutual Funds?

When investing in the stock market, one question that comes to an investor's mind is 'how is investing in stocks is different from investing in mutual funds?' Don't they both put our money into the stock market? If yes, then how do they differ?

If you too are confused about this, then read on to understand how investing in stocks is different from mutual fund investment.

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Also Read: Why Stock Market Downfalls Are Actually A Buying Opportunity

Investing In Stocks

Stocks are financial instruments issued by companies that give the investor part ownership in a company. Simply put, a stock is a security that represents the ownership of a fraction of a company. This entitles the owner of the stock to a proportion of the company¡¯s assets and profits in proportion with how much stock they own. Further, units of stock are called "shares."

Investing In Mutual Funds

Simply put, Mutual funds are professionally managed investment schemes which pool in money from you and other investors and invest it in various securities like stocks, bonds, cash etc. When you buy a unit of a mutual fund, you are purchasing a part of the fund portfolio's value, to be precise. The mutual fund house issues units to the investors in accordance with the quantum of the money invested by them, with the number of units depending upon the NAV at which the units were purchased.

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Risk Involved In Stocks & Mutual Funds

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Also Read: Explained: Sensex, Nifty & Their Role In India's Stock Market

Now, let us have a look at the risks involved in stocks and mutual fund investments.

Stock market involves risks for both the stock as well as the investor. The stock that you purchase, has to face risks like headline risk, credit rating risk, risk of obsolescence, detection risk, commodity price risk, interest rate risk and inflation risk. Click here to understand these in detail.

Whereas you as an investor, have to face risks such as company risk, market risk, interest rate risk, regulator risks, inflation risk, liquidity risk and taxability risk. Click here to understand these in detail.

Wondering how to manage the stock market risk? Click here to know how investors can manage stock market risk.

On the other hand, mutual funds are considered risky because they invest your money in securities, whose values tend to keep fluctuating due to dynamic market movements. This makes them risky, as the NAV of the fund also keeps changing as per the individual security values held in the fund¡¯s portfolio. However, since mutual funds invest in diverse securities of different sectors, they diversify the market risk. Such diversification coupled with the fund manager helps in reducing the market risk of the mutual fund.

And yes, mutual funds too, invest your money in stock market when building portfolio of securities, but it's this diversification across different securities that reduces the overall risk in mutual funds vs stocks. The extent to which your money gets invested into equities depends on the type and category of mutual fund.

What Determines The Capital Gain/Loss in Stocks vs Mutual Funds?

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As far as capital loss/gain through stocks is concerned, the market price of the stock at the time of selling and purchasing is what decides the profit or loss on the share sale. If you sell the stock at a higher price than at what you bought, its a profit, whereas if you happen to sell it at a price lower than the purchase price, it¡¯s a loss.

For mutual funds, it's the NAV price at which you purchased and sold the mutual fund units which determine the capital gain/loss.

If your chosen mutual fund scheme witnesses capital appreciation, which can be visible from the increase in NAV At the time of sale versus the NAV at the time of purchase, you can book capital gains. Whereas if the NAV is running lower than the purchase NAV and you decide to sell the mutual fund units, you will incur loss.

Also Read: Frequently (Not) Asked Questions - How Much Tax Am I Paying On My Mutual Fund Investment?

Investing In Mutual Funds v/s Investing In Stocks

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Investing directly into the stocks of a company is a completely different ball game when compared to investing in mutual funds. As stocks involve direct purchase of shares of the listed companies, this direct route involves much higher risk, since stocks are vulnerable to the market conditions, especially in the short term. And it's your decision that will anchor your capital gains/losses on those stocks. So, your research about the chosen stock and the timing as well as price of stock during sale and purchase hold a key role in determining what you get out of that investment.

On the other hand, investing in mutual funds implies that you buy a unit of that mutual fund, i.e., to be precise, you are purchasing a part of the fund¡¯s portfolio. And it¡¯s the expert, i.e. fund manager, who takes decisions on your behalf regarding which securities to invest your money in, like bonds, stocks, T-bills etc. and form the mutual fund portfolio. Being professionally managed by the fund manager and the purchase of mutual fund units instead of directly the stocks is what makes the risk in mutual funds lower vis-a-vis investing directly into stocks.

That's why its often advised that investors who are novice and wish to invest in stock market, should ideally invest in mutual funds as they tend to involve relatively lesser risk and benefit from the presence of professionals and experts in the form of fund managers. Being a novice and directly investing in stocks can land you into losses due to wrong decisions.

Also, given that mutual funds have a wide array of categories to cater to different investors, this makes them an even more prudent option for investment. You can invest in debt funds, equity mutual funds or hybrid funds, as per your risk appetite, investment horizon and financial goals. Additionally, there are sub-categories like short term debt funds, liquid funds, large cap funds, small cap funds, aggressive hybrid funds, balanced hybrid funds etc. that need to be considered. With mutual funds, you have the flexibility to invest through SIP or a lump sum route.

Moreover, you can always approach financial advisors whenever you feel unsure or stuck when investing or planning to invest in stocks and mutual funds. It's better to benefit from their expertise rather than solely relying on guesswork.

Also Read: Find Out If You Should Include Debt Funds In Your Equity Heavy Mutual Fund Portfolio

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