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July 9, 2022
Today, there are a number of different ways to grow and invest your money. Mutual Funds is one of them and arguably the most popular after shares. Let’s look at a comparison of mutual funds vs stocks, ETFs, Gold and other asset classes. Let’s begin!
Welcome to the battle royale! On one side, we have Mutual Funds, popularly known as MF. On the other we have four promising contestants; ETF, Index Funds, Stocks, and the old veteran, Gold. Let us see who emerges victorious in the battle of investment methods. Let’s get started!
Mutual funds - a quick introduction
Mutual funds are created by fund houses, also known as Asset Management Companies, where they create a basket of stocks, bonds, and other securities. This basket is then offered for investors like you and me to pool-in money. In return, units are given in place of the amount of money invested. The performance is regularly tracked, and whenever you choose to redeem your units, you’re paid back as per the Net Asset Value (NAV) of the fund on that particular day.
Mutual funds are easy, convenient and simple. There are various types like equity, debt, hybrid schemes, and several subcategories such as large-cap funds, mid-cap funds, liquid funds, etc. But they are not the only investment option available to you. Let’s explore four other popular heavyweights of wealth creation and have a quick comparison with MFs in the process.
Mutual funds vs stocks
When companies get listed publicly, they release shares (cumulation of shares is stock) to the investor community, who can then buy and sell these shares, or stocks, on the stock exchange under its rules and regulations. This is a direct investment, and your returns are significantly dependent on the company’s performance.
Markets can never be accurately predicted, and volatility is a known risk. Bear crawls (sluggish market performance) and bull runs (rapidly rising stock prices) can happen anytime, shrinking or inflating your corpus. Delving deeper:-
Risk hedging
Mutual funds too, are dependent on the market performance of their underlying net assets; however, unlike stocks, they are less actively impacted. In other words, owning mutual fund units doesn’t mean you own a direct share of the company. Moreover, mutual fund baskets can contain stocks of a variety of companies, commodities and other assets. This helps balance out the overall performance even if one asset performs poorly or below expectations. 1 point for MF.
Tax benefits
Equity Linked Savings Scheme, ELSS, a type of mutual fund, provides tax benefits under section 80C of the Income Tax Act of India. A total of ₹1.5 Lakh per annum can be deducted from your taxable income, thereby reducing your tax liability. Stocks offer no such benefit. 2 points for MF.
Convenience while investing
MFs allow you to invest either in lump-sum or through SIP. Small amounts can be invested regularly in exchange for ownership of units. In stocks, there is no concept of fractions and decimals. More often, the amounts need to be a one-time investment compared to, say a ₹1000 monthly SIP.
Another important aspect is that regulations require you to have a Demat account prior to trading in stocks. There is no such requirement for investing in MF, which can be done directly through your bank account by yourself, through a broker, or an intermediary.
I hope you’re keeping score, 3 points for MF.
Cost of investment
Fund managers manage mutual funds. To pay them and their team for the management services, mutual funds charge a fee known as the expense ratio. This is deducted from your overall returns and ranges from 0.7 to 1.5%. Moreover, if you invest in MF through brokers or banks, you may also be required to pay 0.3 to 0.5% more than direct MF investment.
In the case of stocks, you can buy them individually through your Demat account; however, there may be nominal charges for each trade and an annual maintenance charge levied by the broker. Many people opt for trading with discount brokers who have significantly lower charges. This works well for experienced traders and costs less as well. 1 point for Stocks.
Investment horizon
Experts will tell you that mutual funds provide actual value for mid-to-long term investment periods. 3-5 years is the minimum recommended tenor, with 10+ years being ideal. What about short term goals and needs?
You can easily achieve your short-term goals using stocks as an investment product. Moreover, stocks are more accessible than mutual funds with no lock-in whatsoever. So, accessibility and short term gains give 2 points for Stocks.
Mutual Funds vs ETFs
ETF stands for Exchange Traded Funds. This is like a union between stocks and MFs because, technically, they are funds and not shares, but you can buy and sell them on the stock exchanges just like regular stocks. So, the benefits of share trading apply to ETFs, while the advantages of MFs remain the same as above.
A notable aspect of ETFs is that they are deemed less volatile, hence less risky than shares. This is because ETFs have a collection of commodities, stocks and bonds, which balance out the overall performance. This is why most investors use an ETF to hedge their portfolios and gain dividends on ETFs, which is usually not the case in MFs.
Mutual Funds vs Index Funds
Comparing these two is like having contestants from the same family. Index Funds are nothing but a type of MF, therefore, they come with almost all the same advantages. However, let us examine the specifics of Index Funds and how they differ from traditional MFs.
Index Funds are built for replicating the performance of a stock market index such as BSE Sensex, Nifty 50, S&P 500 and so on. They are more of a passive investment tool as they contain the same set of stocks that form the index they are following. This reduces the need for administration and fund management activities, leading to lower expense ratios. The risk level is, notably, lower than equity funds.
Index Funds are ideally suited for newbies or those who do not possess the knowledge or the desire to carry out active market research to identify the funds/stocks to invest in.
Mutual Funds vs Gold
The allure of gold has been prevalent for centuries, and it shines as bright today too. If the internet had not made other investing modes so easily accessible then gold, as a commodity, would have received the gold medal in this contest. Pardon the pun.
But do you have the time or the inclination to go through the hassles of checking its purity on purchase? Moreover, the cost of storing physical gold has led to the advent of a new concept called digital or electronic gold. You can conveniently purchase these online with products such as Gold ETFs and Gold Sovereign Bonds. There is no fear of losing it or it being stolen, and if you choose ETF mode, you can sell your virtual gold at your convenience. In fact, you can also choose gold specific mutual funds, adding to the diversity of investment options.
Summary
Clearly, no single solution can fit all. There is no single heavyweight champion as each of these investment methods is meant for different occasions depending on your financial goals and risk appetite. Diversification in your portfolio is one way you can maximise your returns by giving a shot at investing in all of the above products in varying weightage.
Frequently Asked Questions
What are alternative investments to mutual funds?
Considering most mutual funds give you an average return of about 9-12% per year, you could consider investing in bonds, stocks of blue-chip companies (Indian and American), ETFs of foreign stock indices, or even government schemes like the PPF and the NPS. While all of these give you varying returns and have different lock-in periods, they are favourable alternatives to mutual funds and allow you to diversify your portfolio while also giving you tax exemptions.
How are mutual funds different from other investments?
Mutual funds by nature are a way of diversification of wealth as compared to stocks, where you’re betting on the success of a single or handful of companies. They are also different from deposits, and government schemes like the PPF because they don’t have a lock-in period (except for ELSS mutual funds).
Which type of investment is best for me?
It’s hard to say which investment is best for you without knowing what your needs are, but here are some that would qualify as both good and safe investments, largely because they save you tax and also give you good returns.
- ELSS Mutual Funds - This is a class or type of mutual fund that require you lock in an amount for 3 years at a stretch. Also known as tax-saver funds, these funds give you returns of up to 20% per year. ₹1,50,000 of your income is exempt from tax every year.
- NPS or National Pension Scheme - this is a government initiative that lets citizens invest in it at regular intervals. A maximum of ₹50,000 per year is exempt from income tax.
- PPF or Public Provident Fund - Another government scheme that lets you save money into this fund regularly, and at the same time, be exempt from tax for up to ₹1,50,000 per year.
What is an example of a fund of funds?
One example of a fund of funds is the Vanguard Global ex-U.S. Real Estate Index Fund. This FOF invests in other mutual funds or exchange-traded funds (ETFs) that focus on international real estate investment trusts (REITs). The goal is to provide investors with exposure to a diversified portfolio of global real estate holdings. Another example is the Blackstone Alternative Multi-Manager Fund, which invests in a variety of other alternative investment funds, including private equity, hedge funds, and real estate funds.
Is fund of funds the same as mutual fund?
No, a fund of funds (FOF) is not the same as a mutual fund, although both are types of investment funds. A mutual fund is an investment vehicle that pools money from multiple investors to buy a portfolio of stocks, bonds, or other assets.
A fund of funds, on the other hand, is an investment vehicle that invests in other investment funds. The goal of a FOF is to provide investors with exposure to a diversified portfolio of funds, which can help to reduce risk and potentially enhance returns.
