Difference Between Shares and Mutual Funds

Both mutual funds and the share market are popular investment avenues in India. Both offer the possibility of good returns through capital appreciation, but also come with certain risks. As an investor, you must understand the difference between mutual funds and the share market to make informed investment choices about building your portfolio.

This article outlines what are the differences between shares and mutual funds, the pros and cons of mutual funds, pros and cons of stocks, and how to choose between the two.

What are Shares?

Before we proceed to the differences between mutual funds and the share market, it’s essential to first clarify what shares are. Shares are equity ownership in the issuing company. When you purchase shares of a company, you become a shareholder and attain partial ownership in the company.

Shares are typically issued to raise capital for various purposes like funding new projects and financing operations. Companies first issue shares in the primary market through an initial public offering (IPO). Post IPO, these shares are then traded on the secondary market through stock exchanges like the BSE and NSE.

As a shareholder, you are entitled to a proportional claim over the company’s profits and assets. The performance of your investment is directly linked to the performance of the company and the market demand for its shares. If the company performs well, share prices will rise, resulting in potential capital appreciation. The issuing company may also declare dividends.

What are Mutual Funds?

Now that you know what shares are, let’s briefly understand the concept of mutual funds. Mutual funds are investment instruments that pool money from different investors and invest the pooled corpus into various assets.

Depending on the objective of the mutual fund scheme, it may invest in equity assets (equity funds), debt instruments (debt funds) or a mix of both (hybrid funds). It is important to note that owning units of an equity fund does not give you actual ownership of the underlying asset. In other words, you do not have the same rights and privileges as a shareholder. This is a major difference between mutual funds and shares.

Another significant difference is professional management. Unlike shares, each mutual fund is managed by an experienced fund manager who is responsible for selecting assets, monitoring the fund’s performance, and rebalancing its portfolio to ensure good returns in changing market conditions. You can also use an SIP Calculator to plan and estimate your mutual fund investments, helping you invest systematically with clear financial goals.

With clarity on what mutual funds are, we can now proceed to the detailed analysis of mutual funds vs. shares.

Difference Between Shares vs Mutual Funds

As outlined in the definitions above, both mutual funds and the share market have several dissimilarities. The following table sums up the differences between mutual funds and the share market to help you make better investment decisions.

While this table represents the major differences between mutual funds and the share market, it’s important to understand that both investment options offer some distinct advantages and disadvantages. Moving forward from the mutual funds vs. shares comparison, we now focus on the pros and cons of each in detail.

Pros and Cons of Shares

Apart from the differences in mutual funds and shares, it’s also critical to understand the pros and cons of stocks. The various pros and cons of stocks listed below can make it easier for you to decide if shares are indeed the right investment option for you.

Pros of Investing in Shares

• Return potential: Investing in shares of growing companies and emerging sectors can offer return potential, especially over a long-term horizon.
• Ownership benefits: One of the major advantages of choosing shares in the mutual funds vs. shares debate is the ownership stake you enjoy. Investing in shares makes you part owner of the company, granting you voting rights on essential decisions like acquisitions and executive appointments.
• Hedge Against Inflation: Historically, shares have offered inflation-beating returns over the long run. Adding shares to your investment portfolio can help preserve the value of your real returns.
• Dividend Income: As a shareholder, you can earn regular income through dividend distribution. Apart from the general capital appreciation in terms of share value, this can be a good source of passive earning.
• Liquidity: Shares are liquid investment instruments since you can easily buy and sell shares on the stock exchange. You can quickly convert your investment into cash if the need arises.

Cons of Investing in Shares

• Volatility: Share prices can fluctuate significantly over the long term as well as in a single day due to various factors like market sentiment and company performance. These fluctuations can impact your total portfolio value and result in short-term losses.
• Market Knowledge Requirement: Investing in shares requires in-depth market knowledge, analysis capabilities, and an understanding of market trends. If you do not possess these qualities, you may incur hefty losses.
• Risk of Loss: Risk is also an important factor to consider when choosing whether to invest in shares vs. mutual funds. If you invest in shares, the probability of losing your entire investment can be high, if the company underperforms or goes bankrupt.
• No Assured Returns: Unlike fixed-income assets like fixed deposits, shares do not offer guaranteed returns. Returns are purely based on the performance of the stock.
• Taxes and Brokerage: Investment in shares is subject to capital gains tax (based on the holding period) and the securities transaction tax. Dividend income is also taxable. Additionally, you have to pay brokerage fees for each trade. All this can eat your total earnings from the investment.

Pros and Cons of Mutual Funds

Understanding the pros and cons of mutual funds can make it easier to grasp the difference between mutual funds and the share market. We have listed the pros and cons of mutual fund investing below.

Pros of Mutual Funds

• Built-in Diversification: A major difference between mutual funds and the share market is that mutual funds invest in a diversified portfolio of stocks, bonds, and other money market instruments to hedge risks associated with a single stock, sector, or asset class.
• Professional Management: Mutual funds are professionally managed by experienced fund managers. They are responsible for selecting the assets for investment, monitoring it, and rebalancing the portfolio according to the fund’s objectives to maximise returns for the investors.
• Affordability: Another difference between mutual funds and the share market is the affordability aspect. Mutual funds allow investors to begin with nominal investments via systematic investment plans (SIPs), making it easier for small investors to partake in diversified investment opportunities.
• Liquidity: Mutual funds are highly liquid investments since investors can sell their units at the current NAV and redeem their investments at any time.
• Tax Benefits: Investors can claim tax benefits of up to Rs. 1.5 Lakhs under Section 80(C) of the Income Tax Act by investing in ELSS funds. This can help them lower their overall tax liability.

Cons of Mutual Funds

• Investment Costs: Mutual funds charge administration and management fees in the form of an annual expense ratio. This ratio can vary from 0.80%-2.25% of the daily net assets. Expense ratio charges can affect your returns over time.
• Market Risk: While mutual funds are less riskier than shares, they still carry a certain degree of market risk. Fluctuations in the market can impact the value of the fund’s underlying assets. So, if the market underperforms, investors may have to bear losses.
• Lack of Control: A key difference between mutual funds and shares is the aspect of control. The fund manager makes investment decisions as per the fund’s objectives and market conditions. Individual investors have no control over the investment decisions.
• Exit Fees: Mutual funds charge an exit fee if the investor exits the fund before a specified time period. This fee can limit the liquidity benefits of mutual funds to a certain extent.

Why Some Prefer Mutual Funds Over Individual Stocks

Beginner investors often face the same dilemma: Should I invest in mutual funds or stocks? Based on the differences between mutual funds and shares, many tend to side with mutual funds (MFs) in the mutual funds vs. share market debate. Investors prefer MFs over shares for the following reasons:

• Passive Management: Investing in stocks requires active management, market analysis, and trend tracking. If you have limited time, this can become challenging. However, when you invest in mutual funds, you can pass on the burden of asset selection, timing trades, and monitoring their progress to the fund manager. This significant difference between mutual funds and shares makes MFs ideal for passive investors.
• Diversification Perks: If you wish to build a diversified share market portfolio, you will have to invest in multiple stocks from varied sectors and market capitalisations. Since mutual funds invest in a varied basket of securities, they offer instant diversification benefits, and you get exposure to a broad range of securities without having to individually select stocks.
• Professional Management Benefits: From the shares vs. mutual fund comparison highlighted above, it’s clear that you need market knowledge and expertise to make stock market investments. Beginners generally lack such market knowledge, which makes them more susceptible to losses. In the case of mutual funds, professional and experienced fund managers make investment decisions, making them most suited for beginners with limited market knowledge.
• Reduced Investment Costs: Stock market trading is often linked to relatively high brokerage fees and transaction costs. Moreover, building a diversified portfolio means investing in 20-25 different stocks, resulting in a high initial investment. Investment costs of MFs are capped at a fixed rate (expense ratio). Additionally, since mutual funds pool funds from different investors to invest in a diversified basket of assets, you can tap into diversification benefits at a comparatively lower cost.

Conclusion

Every investor must understand the differences between mutual funds and shares to make informed decisions. The above discussion highlighted what is the mutual funds vs. shares debate, focusing on the pros and cons of stocks as well as the pros and cons of mutual funds. In a nutshell, the differences between mutual funds and shares sum up how each investment instrument caters to different investor preferences. While professionally managed mutual funds help investors tap into the benefits of high returns without having to select stocks individually, shares offer direct equity ownership in a company. Ultimately, deciding whether to invest in mutual funds vs. stocks entirely depends on your investment goals, risk appetite, and market knowledge.