When the markets are on a roll, a common dilemma that investors (mostly new ones) face is: "Can I beat mutual funds and get higher returns by investing in stocks directly?" And many believe they can do it. The latest data from the Central Depository Service and National Securities Depository shows that the total number of demat accounts in India has now crossed 13.93 crore, which is up almost 29 percent from a year ago (source).
It won’t be wrong to say that the recent rally on Dalal Street has created the perception that ‘making money from direct stocks is easy’ and hence, more and more people are taking the direct stock picking route.
But is it really a good idea to shun mutual funds and just go into direct stock picking?
Based on the little experience I have had in the markets over the last one and a half decades, I can say that the common answer you get for this question from people will vary depending on how markets have been doing. In bull markets, it’s easy to pick stocks and make more money than mutual funds give you. But in bear markets, the reverse happens. So, the answer will change based on whom you ask and when you ask.
That said, and to be fair, there’s no straight answer to this question of choosing between mutual funds and direct stocks.
But in my view, for most common investors, mutual funds (and not direct stocks) should form the core of their equity exposure. This may not sound right when markets are doing well. But most small and common investors neither have the time nor the skill to properly analyse stocks. Also, most people don’t realise this, but picking good stocks is one thing, building a good portfolio of stocks is another thing, and lastly, making money in markets is an entirely different art.
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Hence, investors who don’t have deep knowledge about the markets or business may find greater success with mutual funds and favourable investment outcomes.
While it is true that if one goes for direct stocks, there is a lot more freedom to build a concentrated portfolio of stocks that can deliver much higher returns than basic mutual funds, it also means that if just a few of those stock picks do very badly, then a concentrated portfolio of direct stocks can crush the investor.
So, the potential for higher returns in direct stocks does come with additional risks. People who know would understand, while those who have just joined the markets in the last few years will ignore such risks because they have yet to see the brutal side of falling bear markets.
Please don’t get me wrong. I am not saying direct stock investing is bad. All I am saying is that it isn’t as easy as it may seem when you look at the last one year’s returns in a bull market.
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So, what to do?
Whether you should go for direct equity pickings or invest through equity mutual funds is eventually a personal choice. But if I was asked about what should be done, then here are a few pointers to keep in mind:
- I suggest investing the core long-term allocation in equity mutual funds first. While there are hundreds of schemes to pick from, you just need a few funds from suitable mutual fund categories to diversify sufficiently across different marketcap segments.
- Once that is done and you are still interested, only then should you begin your direct stock journey. Start by investing a tiny portion of your portfolio directly in stocks based on your research.
- Please do not invest in stocks based on random tips you see on social media or in the news.
- Over time, as you keep researching businesses/stocks and your understanding of the market increases, you can consider increasing your allocation to direct stocks.
- In a few years, if you compare your investment returns from mutual funds and direct stocks, you will get to know which is working better for you. So, you can take a call accordingly as to which path to focus on in the future.
Note (and in all fairness) – The article above is for common investors. Those who have been investing for years, have a reasonably good track record, and understand the nuances of profitable stock picking, can definitely take a path different from what is discussed above.
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