Why you should invest in mutual funds

MF schemes suit goal-based portfolios more than direct investment in stocks

Should you invest directly in the stock market or buy mutual funds for accumulating wealth to achieve your life goals? We address this question because many individuals believe that buying shares of ‘fundamentally good’ companies will give good returns, enabling them to accumulate wealth to meet their life goals. We show why mutual funds are more optimal for goal-based portfolios than direct investing in stocks.

Behavioural urge

You may prefer direct investment in stocks for several reasons. One, you have better control over your investments, or so you may believe. But that is not true. Why? Your equity investments appreciate in value for two reasons — market-related factors such as the RBI revising interest rates, and company-specific factors.

Now, your portfolio’s return primarily comes from market-related factors. And you have no control over them. So, you are exposed to high risk whether you invest directly or through a mutual fund. Direct investing, however, gives a feeling that you can control your investments.

Two, you may believe that the stocks you pick could perform better than an average active mutual fund. You may be right, even though psychologists may call this overconfidence bias. But can you consistently beat the average mutual fund? That may be difficult for two reasons. For one, you need a lot of luck, in addition to your skills, to generate returns. Of course, that is true of a mutual fund manager, too. For another, your return also depends on when you sell your shares, not just what you buy.

Often, this is an area where most individuals do not fare well. Why? You face regret if you sell early and the stock subsequently moves up. You also face regret if you sell late and the stock subsequently declines. You can outsource this decision to a fund manager by investing in a mutual fund.

Outsourcing moderates your regret because it is easy to blame the fund manager when your investments perform poorly. True, blaming the fund manager is not going to take away the fact that your investments have declined in value. But it does moderate your regret. Also, you are emotionally attached to your investments. A fund manager is typically not attached to the portfolio she manages. Therefore, it is easier for a fund manager to cut losses in the portfolio than for you to do with your investments.

There are also other positives of investing in mutual funds.

Emotionally optimal

Mutual funds offer a disciplined way to investing through systematic investment plans (SIPs). For one, it enables you to moderate your urge to spend most of your current income. An SIP on a mutual fund moderates regret because the automatic monthly debit to your bank account distances you from your investment decision.

You cannot set up an SIP when you buy stocks directly, unless you buy the same stocks every month. But that may not serve your purpose. Why? Your objective is to pick ‘fundamentally good’ companies at a good price. Setting up an SIP presupposes that your stock picks remain ‘fundamentally good’ for a long time, and are available at reasonable prices. That may not always be possible.

Finally, it is easy to manage your mutual fund investments. You have to invest in one index fund or 2-3 active funds for a goal-based portfolio. In both cases, you have fewer investments to manage during the time horizon for your life goal. Contrast this with the experience you will have when you are forced to track 15-20 stocks in your direct equity portfolio.

The writer is founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in

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