Whilst the concept of a stock market may be easy to grasp stock market, understanding its nuances and making sound investment decisions is a tricky game. Researching stocks in order to their investment potential requires a fair amount of time, knowledge and experience. Previously, it used to also involve significant transaction costs due to brokerage charges. All of this acts as a barrier for many people and reduces the overall amount of investment stock exchanges and reduces the ability of individuals to grow their wealth.
Mutual funds emerged as a solution to this. These allow multiple investors to pool together money by investing in one common fund, which is then invested in a basket of stocks by a fund manager. The fund manager charges a fee for this service. This allowed common people to be able to participate in the stock market and reap its benefits.
As stock markets grew, discount brokers allowed investors to trade in stocks with little to no transaction fees, through free demat accounts. In a market where you can transact almost for free, and have access to incredible amounts of information on the market, is it still worth investing in mutual funds instead of individual stocks? Yes, and here are a few reasons why.
With mutual funds, you are not only paying to invest in the fund, but the fee you are charged is also for the expertise and facilities of the fund house you are investing with. Since they have spent resources in equipping their team with sound technical knowledge, you are paying to get access to the benefits of this knowledge, which is always likely to surpass the insights you could achieve yourself, particularly if you have conflicting responsibilities. Note, however, that this does not ensure you will always make good returns, as even mutual funds can underperform.
With individual stocks, you will have to study each stock, and assess whether each one is worth buying. A mutual fund, on the other hand, has a basket of stocks that they focus on, routinely studying and updating it. As a result, you get a higher level of diversity with mutual funds. This also reduces the risk that you may exposed to. Depending on the kind of risk-reward ratio you are comfortable with, you invest in mutual funds with different investment philosophies, such as those only primarily invest in large-cap stocks, or those targeting middle and small-cap companies as well.
Even if there is no direct fee to stocks, there is often a transaction cost that is charged. If you are investing in stocks on an individual basis and also actively trying to reconstruct your portfolio, these can add up over time. With mutual funds, however, you pay one fee, albeit a little higher, to invest in a number of stocks at once and let the manager take care of the portfolio construction.
One of the biggest advantages of mutual funds is that it is convenient. You don’t have to spend the time and effort picking individual stocks, as this is done for you by the fund manager.
Mutual funds and stocks offer you a number of benefits and drawbacks. While mutual funds are convenient, they come with a fee, and while stocks might have no fees, they require more time and effort. The best approach would be to have a diverse portfolio, one that consists of a number of investments, including stocks and mutual funds.
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