A Moneylife Foundation event discussed the better route for investing
Investors have an option to invest in stocks of good companies directly or they can get exposure to stocks through equity mutual funds. Which route should they choose? Our research shows that investors familiar with financial terms who can spend some time and resources to research stocks could generate higher returns from stocks. One of the reasons is costs.
Debashis Basu, trustee of Moneylife Foundation, explained how stocks score over equity funds in terms of costs with several examples. If one has a huge corpus to invest, over a long period, equity schemes turn out to be more costly compared to stocks. The reason is that for mutual fund investment you pay a fee—expense ratio—which is a percentage of the market value of the corpus. In the case of stocks, you need to pay fixed annual maintenance charges and one-time transaction charges, which work out to be a tiny percentage of the amount over the long term.
“Costs eat into returns. In equity schemes, the fees charged can range between 1.25% and 3% per year. In percentage terms, it may seem small, but as your corpus grows, you are paying higher fees in percentage terms,” explained
Many people tend to avoid stocks as they are considered riskier than equity funds. “There is no difference in risks between buying stocks and holding funds,” Mr Basu explained. Both are volatile and can fall sharply leading to a loss of capital. In terms of returns, however, a diversified portfolio of quality stocks will be expected to outperform most equity schemes over the long term, he added.
He emphasised repeatedly that equity funds are wonderful instruments and those who have no time and interest to analyse individual stocks or those who have a low investment corpus should go for equity schemes. Equity schemes would be ideal for those who are just beginning to invest and are looking to invest small amounts. However, when they gain confidence and have larger corpus, they need to look at stocks because of higher costs of staying invested in funds.
In terms of stock selection, too, most equity schemes are not very efficient, Mr Basu said, the funds stick to the same basket of stocks and are heavily weighted to their benchmark stocks. To win at stock-picking, Mr Basu said that one should select stocks with high return on capital and hold them for the long term. The packed seminar ended with a lively interaction.