What Is The Difference Between Stocks & Mutual Funds?

. 5 min read
What Is The Difference Between Stocks & Mutual Funds?

Which Is Better Mutual Funds Or Stocks?

  • Investing for the future can seem like a very intimidating task.
  • With a wide variety of options and purposefully jargonistic language to cover these options, it might seem like you need the help of a financial consultant to make any sense of investment strategies.
  • However, with some patience and dedication to understanding financial products and policies, you too will be able to traverse the field of investments.
  • When you begin to plan for your financial health, and in particular look for investment opportunities, the products that are recommended immediately are stocks and mutual funds.
  • As a traditionally conservative financial society, it can be very hard to find good and reliable information on these recently popular financial products.
  • Here, we will discuss what stocks and mutual funds are, the differences between the two, and which product is most suited for your investment plans.

What Is A Stock?

  1. Essentially, a stock represents a fraction of the ownership of a corporation.
  2. When you own a stock of a company, also known as equity, you own a fraction of said company’s profits and assets.
  3. These stocks are traded on a stock exchange or even over-the-counter.
  4. Trading here refers to the buying and selling of stocks.
  5. Why do companies choose to offer stocks to the public?
  6. It isn’t out of any altruistic sense of sharing their profits.
  7. Rather, it is a move that allows them to access capital from the public.
  8. So, instead of waiting on a bank to give them a loan or liquidating an asset, the company can quickly access capital from its stockholders.

What Are The Different Types Of Stocks?

Stocks can be classified based on a number of factors which includes ownership rules, dividend payment, risk, and fundamentals.

Ownership-Based Classification

  1. Preferred Stocks– These stocks come with the promise of a fixed amount to be paid every year. They are given priority over a company’s income. However, the holder of these stocks does not enjoy any voting rights.
  2. Common Stocks– A common stock represents fractional ownership of the corporation and enjoys voting rights when it comes to electing board members. These are the types of stocks people are most familiar with.
  3. Hybrid Stocks– These are preferred stocks that come with the option of converting to common stocks after a set period of time.

Market Value-Based Classification

  • Stocks are also classified based on the market value of the corporation which is derived by multiplying the price of a single stock by the total number of shares issued by the corporation.
  1. Large-Cap Stocks– These are the stocks of the biggest companies in the market like Apple, Amazon, Tata, and Reliance.
  2. Mid-Cap Stocks– Mid-cap stocks belong to corporations with a market value of around Rs.200-4000 crore.
  3. Small-Cap Stocks– These stocks represent small companies with a market value of around Rs.250 crore.

Risk-Based Classification

  • This type of classification is crucial when you are planning your investment strategy.
  • Since some stocks are considered riskier than others, you have to know their potential and their possible risks.
  1. Blue-Chip Stocks– These are considered safe and reliable stocks, usually representing large companies with stable growth and low debt.
  2. Beta Stocks– These stocks are riskier. Beta stocks usually represent small or new companies that depend heavily on the volatility of the market.
  • Now that you know the basics of what stocks are, we can discuss mutual funds.

What Are Mutual Funds?

  • A mutual fund is a slightly more complex financial product than stocks.
  • Think of it as a pool of money, sourced from various investors, and is managed professionally.
  • The entire pool of money is then invested in various securities like bonds, stocks, and other assets.
  • Each mutual fund is individually designed with its investment objectives.
  • The professional money management works towards investing the fund, or pool of money, to achieve these objectives.
  • You must read the investment objectives before investing in a mutual fund.
  • The returns you enjoy from a mutual fund is proportional to the amount that you have invested in the pool.
  • Most mutual funds operate either based on an annual fee or charge a commission on the returns.
  • You must consider this when making your investment plan.

Stocks Vs. Mutual Funds

  1. Stocks and mutual funds are equally valid investment opportunities whether you are a novice or an investment expert.
  2. However, it is important to understand the difference between the two to know which one of these financial products will suit your financial plan best.
  3. Here are the key factors of difference between mutual funds and stocks.

Overall Costs

  • Since a mutual fund is managed professionally, the charges you pay for the services are higher than those you would for trading stocks.
  • You should keep this in mind particularly if you are not investing a large sum of money and do not want your returns to be eaten up by charges.

Investment Risks

  1. Investing in stocks is riskier than investing in a mutual fund.
  2. A mutual fund has a diverse portfolio of investments that range from stocks to bonds to FDs.
  3. Since you have to buy at least 10-15 stocks of a corporation to make it a worthwhile investment, your investment is subject to the volatility of the stock market as well as the individual performance of the corporation you choose.

Returns Potential

Since stocks are riskier, the potential of a better return is higher. Many people like Warren Buffet have made most of their wealth through the stock market. However, it is important to note that you will make money through stocks only if you do diligent research and follow the market closely. This is why most people lose money on the stock market. Mutual funds have a lower risk and the chances that you will make a profit through them are higher.

Taxation

  • Certain mutual funds are given a tax exemption and even if certain parts of the portfolio are sold, you do not have to pay any tax if you still hold the fund.
  • On the other hand, there are no such exemptions offered to stocks.
  • You are required to pay capital gains tax on any returns you make on stocks.

Time Investment

  1. A mutual fund is managed through professional money managers, and you will have a hands-off experience with the actual investment procedures.
  2. With stocks, you will have to research the markets, find suitable companies to invest in, give instructions to your stockbroker to invest.
  3. Even if your stockbroker provides advice and deep financial advice, you are ultimately deciding where and how much to invest.
  4. However, most mutual funds are long-term investment products with most funds having a period of 5-7 years.
  5. Stocks can be either short or long-term depending on the company you are investing in and the market volatility.

Investment Control

  • With stocks, you are fully in the driver’s seat.
  • You get to decide which stocks to buy, when to buy, when to sell and how many to sell according to your needs.
  • This feature is not available for mutual funds.
  • At most, you can decide which mutual fund to invest in.
  • You must also keep in mind that a mutual fund is only as good as its manager.

Conclusion

  1. Stocks and mutual funds are two very different, but entirely viable, options for investors with any degree of experience.
  2. Deciding on whether to invest in either requires that you do your due diligence and research the products to your best capacity.
  3. A healthy investment portfolio will usually have a mix of both these products since they can fit into different aspects of a robust financial plan.

Also Read:

1) What are some differences between property tax & wealth tax in India?
2) How are crypto-currencies taxed in India?
3) How to get your business listed on the Stock Exchange?
4) How does the share market work?