Mutual Funds vs Stocks: Key Differences, Risks, and Taxation Explained
Can you imagine how investing can feel a lot like dining out? On one hand, investing in stocks is like cooking your own meal-you pick the ingredients, decide the recipe, and take full credit for the profit, or at worse, take the blame for the loss as well.
On the other hand is the choice of mutual funds, which is like eating at a restaurant-a professional chef (fund manager) does the main work, while you enjoy a ready-made dish.
Both can satisfy your hunger for wealth, but in very different ways, right? So what exactly are the differences between stocks and mutual funds? Check out this blog as we explain it all.
What Are stocks?
Stocks are financial instruments issued by companies that give you partial ownership in a company. It is a security that represents a fractional ownership of the company. You, as an investor, can buy or sell these units of ownership on the stock exchange.
What Are Mutual Funds?
Mutual funds are professionally managed investment schemes which pool in money from various investors and then invest that pooled money in various securities like stocks, bonds, etc.
The mutual fund house issues units to you (the investor) as per the amount of money invested by you, with the number of units depending upon the NAV at which the units were purchased.
Risk Involved In Stocks & Mutual Funds
Both stocks and mutual funds involve their own set of risks, but the latter generally spreads the risk through diversification and professional management, while stocks require a higher degree of research and monitoring.
Risks Involved in Stocks
1. Market Risk: Stock prices keep going up and down due to factors such as overall market movements, economic changes, etc.
2. Business Risk: Issues such as poor leadership, competition, or financial downturns can directly impact a company’s stocks.
3. Concentration Risk: Investing your money into a single stock or a particular sector can make your portfolio risky and result in losses if that sector/stock underperforms.
4. Regulatory and Political Risk: Any change in laws, policies, or unstable governments can affect a particular stock or even a larger segment of the stock market.
Risks Involved in Mutual Funds
1. Market Risk: Like stocks, mutual fund’s NAVs also keep going up and down based on broader market and economic conditions, though the degree of movement may not be as sharp or big as a stock.
2. Interest Rate Risk: This factor primarily affects debt mutual funds, as rising rates can lower the value of fund’s bonds, and vice versa.
3. Credit Risk: This is another risk pertaining to debt mutual funds, in case the bond issuer defaults on repayments.
4. Manager Risk: The mutual fund manager’s decision-making certainly impacts the scheme’s returns, so poor strategies or decision making can become a reason for the fund’s underperformance.
5. Concentration & Sector Risk: Mutual funds focused on a specific sector/theme tend to carry an extra risk if that sector/theme performs poorly.
How Do You Earn In The Case Of Stocks vs Mutual Funds?
In the case of stocks, the market price of the stock at the time of buying and selling is what ultimately decides your profit or loss on that investment. If you sell the stock at a higher price than at what you purchased it, then its a simple profit, whereas if you had to sell it at a price lower than the one at which you bought it, then you would incur a loss.
As far as mutual funds are concerned, the fund’s NAV determines your capital loss or gain. The NAV (Net Asset Value) is the price at which mutual fund units are bought and sold. It is calculated on a daily basis, thus reflecting the closing prices of all securities in the fund's portfolio.
So, the NAV at which you bought it and sold it ultimately determines your gain/loss. If your chosen mutual fund scheme’s NAV rises and is more than the NAV at which you bought, then you can book the capital gains. On the other hand, if the NAV is lower than the one you bought, then you would incur a loss if you redeem it.
Taxation Of Capital Gains-Stocks vs Mutual Funds
Stocks:
1. If sold on or before 23.07.2024
STCG: Holding period <= 12 months: 15%
LTCG: Holding period > 12 months: 10% (Capital gains up to Rs. 1.25 lakh are exempt from tax)
2. If sold on or after 23.07.2024
STCG: Holding period <= 12 months: 20%
LTCG: Holding period > 12 months: 12.5% (Capital gains up to Rs. 1.25 lakh are exempt from tax)
Debt Mutual Funds:
1. Purchased till 31.03.2023
- If sold on or after 23.07.2024
STCG: Holding period of < 2 years: Income Tax slab rate
LTCG: Holding period of > 2 years: 12.5% without indexation
- If sold before 23.07.2024
STCG: Holding ? 36 months: Income Tax slab rate
LTCG: Holding > 36 months: 20% with indexation benefits
2. Purchased on or after 01.04.2023
Taxed as per your income tax slab rate, irrespective of the holding period.
Equity Mutual Funds:
1. If sold on or before 23.07.2024
STCG: Holding period <= 12 months: 15%
LTCG: Holding period > 12 months: 10% (Capital gains up to Rs. 1.25 lakh are exempt from tax)
2. If sold on or after 23.07.2024
STCG: Holding period <= 12 months: 20%
LTCG: Holding period > 12 months: 12.5% (Capital gains up to Rs. 1.25 lakh are exempt from tax)
Conclusion
In conclusion, it's fair to say that both stocks and mutual funds offer unique advantages and risks, catering to different types of investors. While stocks provide the opportunity for direct ownership and potentially higher returns but require more research and active management, mutual funds offer diversification and professional management, thus making them a more convenient option for those who prefer a hands-off approach.
Ultimately, the choice between stocks and mutual funds rests in your hands, depending on your investment goals, risk tolerance, taxation rules, and the level of involvement you wish to have in managing your investments on a day-to-day basis.
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Disclaimer - Investments in debt securities/municipal debt securities/securitised debt instruments are subject to risks, including delay and/ or default in payment. Read all the offer-related documents carefully. The investor is requested to take into consideration all the risk factors before the commencement of trading.
This communication is prepared by Grip Broking Private Limited (bearing SEBI Registration No. INZ000312836 and NSE ID 90319) and/or its affiliate/ group company(ies) (together referred to as “Grip”) and the contents of this disclaimer are applicable to this document and any and all written or oral communication(s) made by Grip or its directors, employees, associates, representatives and agents. This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip does not guarantee or assure any return on investments and accepts no liability for the consequences of any actions taken based on the information provided. For more details, please visit www.gripinvest.in
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