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Equity v/s Mutual Funds, which is safer?

By Elricho Gomes

9th Jun 2022

5 mins read

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There are numerous investment opportunities, avenues, products, and schemes available. Keeping up with changing parameters and market fluctuations can be a daunting task when deciding where to invest your money.

Two such investment opportunities are Equity and Mutual Funds. Understanding the differences in risk and returns between the two is essential in deciding. We will break down both Equities and Mutual Funds to help you decide.

What is Equity?

The amount of capital invested or owned by a company's owner in equity. The difference between a company's liabilities and assets on its balance sheet is used to calculate equity. The current share price or a value set by valuation professionals or investors determines the stock's worthiness.

Equity is the value that would be restored to a company's shareholders if all of the assets were liquidated and all of the debts were paid off. We can also think of equity as the amount of residual ownership in a company or asset after all debts have been paid off.

Equity shares allow investors to own a portion of a company's ownership, allowing them to profit from its profits and the share market's upward rise. The corporations sell their shares to the general public and use the proceeds to fund various business activities. Investors in the company have the right to vote, share in profits, and claim the company's assets.

Advantages of Equity

Potential for Profit- Returns on equities can be better than other investment avenues. Equities reward long term investors with higher returns

Dividend Income-  The dividend is the portion of a company's profit that it distributes to its shareholders. Dividend income serves as a source of income for the company's owners. Dividends are one of the ways through which an investor earns a return on his investment.

Diversified Portfolio- Equity markets allow investors to diversify their portfolios. Diversifying your portfolio helps you manage risk and protects you from erratic stock price swings. The fact that underperformance in one area can be compensated by outperformance in another makes diversification beneficial to the investor.

Limited Liability- The liability paired with the investment is limited to the extent of the investment. Losses suffered by the company above the investment don't affect the investor.

Exercise Control- Investing in a company gives you voting rights to exercise and even have ownership in the company.

Liquidity- The advantage of investing in Equity is that you can sell at any time due to the availability of buyers.

Tax Benefits- Investors in equity shares also benefit from tax advantages. The higher yield on stock shares is due to an increase in principle or capital gains, taxed at a lower rate than other incomes in most countries.

Risks in Investing in Equity

Although there are numerous benefits to investing in Equity, there are risks that investors have to consider as well.

Market risks, for example, could have a direct influence on your equity investments. That means that the value of a company's stock will frequently rise or fall according to market factors, potentially resulting in capital loss and unpredictably fluctuating returns.

On the other hand, a company's worth could plummet if it is overly reliant on a single firm, sector, or country. Along with this, a company's value could plummet due to growing inflation, diluting its value.

Another risk is that the company might fail at dividend payout, or the dividends might be less than the investor expected.

What is a Mutual Fund?

A mutual fund is a professionally managed investment vehicle that pools money from several individuals to buy securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio.

Professional money managers manage mutual funds, allocating assets and attempting to generate capital gains or income for the fund's investors. The mutual fund portfolio is built and managed to meet the investment objectives indicated in the prospectus.

Mutual funds provide access to professionally managed portfolios of shares, bonds, and other securities to small and individual investors. As a result, each stakeholder shares in the fund's gains and losses proportionally.

There are various types of Mutual Funds to fit every individual investor's investment portfolio or investment style. Picking one that suits you is essential to ensure your investments are secured in the manner you prefer.

Advantages of Mutual Funds

Liquidity- Unless you choose closed-ended mutual funds, buying and selling a mutual fund plan is pretty simple. You can profitably sell your open-ended equities mutual fund units when the stock market is high. Keep a watch on the mutual fund's exit load and expense ratio.

Diversification- Since stock market fluctuations determine their performance, equity mutual funds are not without risk. As a result, the fund management diversifies your investment by spreading it among firms from different businesses and sectors. When one asset class underperforms, the other sectors can compensate, preventing investors from losing money.

Expert Management- A mutual fund is a viable option for investors who don't have the time or ability to undertake their research and asset allocation. A fund manager is in charge of everything and decides what to do with your money.

Tax Benefits- You can invest in ELSS mutual funds, which are tax-saving mutual funds that qualify for a tax deduction of up to ₹1.5 lakh per year under Section 80C of the Income Tax Act, 1961. Even though Long-Term Capital Gains (LTCG) over ₹1 lakh are subject to a 10% tax, they have consistently outperformed other tax-saving products in recent years.

Risks in Investing in Mutual Funds

One of the most heard phrases on any mutual fund ads is "mutual funds are subject to market risk." Market risk is a risk that any investor may face due to the market's deficient performance. A variety of factors influence the market. Natural disasters, inflation, recession, political upheaval, interest rate fluctuations, and so on are only a few examples. Systematic risk is another name for market risk.

Interest rates fluctuate based on the amount of credit available from lenders and demand from borrowers. They are inversely related to one another. Increases in interest rates during the investment period may cause the price of securities to fall.

Credit risk also affects mutual funds, particularly debt funds. The fund manager of a debt fund must only use investment-grade securities. However, the fund manager may occasionally add lesser credit-rated securities to maximise returns. The portfolio's credit risk would rise as a result. Examine the credit ratings of the portfolio composition before investing in a debt fund.

Concentrating on a large portion of a person's investment on a single scheme is not wise. Investors can make a lot of money if they're lucky, but they also lose money. Concentrating and extensively investing in a single industry is also quite dangerous.

Equity or Mutual Funds, which is the safer investment option?

Direct equity investment is appropriate for people who have prior experience and knowledge of the stock market. Direct stock investors must make tactical decisions about when to buy and sell shares.

As a result, direct equity can be a suitable alternative if investors are willing to achieve these requirements and devote time. Investors must be aware that the stock market is highly volatile and can result in large movements in the short term.

Mutual funds are a solid option for investors wishing to diversify their portfolios. Instead of putting all of your money into one company or industry, a mutual fund diversifies its holdings to reduce risk in your portfolio.

Like all other securities, mutual funds are investments subject to losses. However, the goal of a mutual fund is to reduce investment risk, so mutual funds can often be less risky than other types of investments due to their diversification.

Equity investments take up a lot of the investor's time and attention and have a higher risk while yielding high returns. At the same time, Mutual Funds don't need to be constantly looked after and are relatively safe and yield considerable returns.

Assessing these factors and comparing them to the portfolio and investment requirements will help decide whether investing in Equity or Mutual Funds fits you.



FAQs

Which is safer Equity or Mutual Funds?

Mutual Funds are safer due to the money being invested in different securities and equity, thus diversifying the investor's portfolio.

Is marker risk a factor?

Yes, market risk is applicable to both of these investment avenues due to the fact that the Mutual Funds and Equities are linked to market fluctuations and changes.

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