New demat account openings surged to 10.7 million, more than double the previous financial year even as equity mutual funds saw outflows this financial year (till Feb end). Mint explains how you can decide between stocks and mutual funds if you are an equity investor.
Which option gives you higher returns?
Your returns depend on your skill at selecting the right stock or mutual fund. However if you do get it right, a single or small portfolio stock can deliver much higher returns. A mutual fund is required to hold multiple stocks and follow the portfolio diversification rules laid down by the regulator, Securities and Exchange Board of India (Sebi). Each of its holdings is unlikely to go up by the same degree at the same time. On the flip side, the diversified nature of a mutual fund also means that it is harder to lose money in a mutual fund than a single stock or small bunch of stocks.
Are MFs pricier than direct stocks?
If you do your own research and pick your own stocks, you can end up paying lower costs compared to a mutual fund. In direct stock buying you pay brokerage while transacting and ancillary costs like demat account charges. However these can work out to be lower than the expense ratios of equity MFs which can go up to 2.25% of the value of your investment every year. That said, MFs allow you the advantage of professional management and a diversified portfolio. If you do not have adequate stock picking skill, the costs of having duds in your portfolio can more than outweigh the expense ratio of a mutual fund.
Which method is better in terms of tax efficiency?
In MFs, you only pay tax on redemption. Any gains realized by the fund manager by switching between stocks or selling stocks are not taxable. But for direct equity, you end up paying tax every time you sell your holdings or book profits in a stock in order to buy another. Dividends from both are taxed at slab rate. Thus, MFs hold an edge over direct stocks in terms of tax efficiency.
Who should opt for direct stocks?
Generally, beginners or people who do not have enough time to research and pick stocks should go for MFs. In the latter case, all these activities are performed by an expert fund management team. High net worth investors may also gain from the tax advantage offered by MFs. In addition, MFs offer diversified portfolios to small investors, for instance someone investing a mere ₹100. Direct stock investing does not allow this, particularly in cases where stock prices have risen and individual shares are worth a lot of money.
Are there any other alternatives?
Yes. High net worth investors can go for portfolio management services (PMS) which have a minimum ticket size of ₹50 lakh or alternative investment funds which have a minimum ticket size of ₹1 crore. These products have fewer regulatory restrictions and can generate higher returns. For retail investors, there are platforms which offer thematic baskets of stocks at a fee. Apart from these you can also invest in equities through products such as National Pension System (NPS), although they come with conditions.