Why is investment in equity mutual funds better than in direct equity?
This has been a strange year!
The conversations we have had with people with respect to their investments have moved in exact sync with the equity market. In January 2020, when the benchmark BSE Sensex was hovering around 44,000 points, we were dealing with questions like ‘Should I shift from Mutual Funds to direct equity’ on a daily basis.
In March, when the Sensex tumbled to 26,000 points, many people, including some referred to in the previous sentence, frantically called us to seek advice. This time, they were panicking and wanted to exit equity altogether, direct as well as mutual funds.
Such questions usually mean only one thing: The investor is very young in the market, and has not seen market cycles.
Now that the market is again hovering close to 40,000 points, many people would like to get a share of the pie and would like to invest in direct equity. After all, the story of Reliance Industries Ltd getting doubled in value in just a few months will make anyone red with envy! FOMO (Fear of Missing Out) further…
Despite that, we are going to argue today that investing through Mutual Funds is a better idea than direct equity.
Well, the caveat is that this is true for a vast majority of people around us. There will certainly be exception of a few people who can spend time and energy to research on direct equity investments.
Why do we say so? The answer is below.
What it takes to ace direct equity investment?
Short answer: Research.
Long answer: Ability to read between the lines when reading news about companies and industry, a knack for thinking ahead of the curve basis the previous two, deduced information that others might not have, and lastly, capacity to handle big big losses!
Accordingly, all our conversations on direct equity investments start with the last question first! That is surprisingly the weakest link.
Remember that a cash-rich giant like Maruti Suzuki saw its share price fall from around Rs 10,000 to Rs 4,000. Will you be able to sleep peacefully if you bought Maruti at near Rs 10,000 when everybody said Maruti is the new Tesla and now your portfolio has that huge dent? It is another story that strong companies also recover from those depths over time.
The other questions revolve around the understanding of a particular industry and company. People who understand a business really well, and can anticipate the changes – positive and negative – for the company basis their analysis are the ones who gain.
Unfortunately, very few retail investors have that kind of time, energy or zeal for more than a couple of sectors. You could be a defence professional and can make investments in related stocks, but do you also understand the global energy market dynamics? Are you confident of your predictions for the automobile industry or the decorative paints sector?
If not, then it is better to stick to mutual funds.
How you gain through equity mutual funds as retail investors?
Most people we speak to are very enthusiastic about equity investments, but unfortunately cannot extend their research or understanding to a sector beyond the one in which they themselves work. You certainly cannot put all of your money in a single sector! It is like keeping all of your eggs in a single basket. One accident and all or most eggs are gone, not even fit for a humble omelette!
On the other hand, if you spread those eggs in different baskets, you can be certain that even if there is an accident at one or a few places, at least some of the eggs will hatch to give you a few chickens!
Okay, let’s think beyond food again.
Mutual funds will enable a defence professional to have exposure to finance, manufacturing, energy, pharmaceuticals, information technology, emerging businesses and all other sectors that we don’t even think about.
A fund manager and her team, managing your mutual fund investments will however, not miss any of these sectors. This is their profession, they get paid for it and the MF industry has huge competition to emerge out as the best fund manager.
Not only will they not miss the sectors, they will also strive to find the best companies in that space for your investments. Of course, they are doing it for a fee, but that is what makes it a truly professional decision!
In the end we would say that, by all means, invest in equity if you have the expertise. But unfortunately, most people do not have that expertise, or worse still, think that they have it due to a few ‘beginner’s luck’ wins.
Hence, for most people, equity Mutual Funds should be their first choice to get an equity exposure for their investments.