Chapter 4: Process or How the heck do I Invest in Equity Successfully?

4.9 Invest in very few Equity Mutual Funds but Smartly


Why invest in Mutual and Index Funds when you have a stock portfolio? Which types of funds could add value to your portfolio? How to choose such funds? How to build a portfolio of funds? How to track the performance of funds? When investing lumpsum is there a right time to do so?  
 
The objective of your investment in equity is to earn healthy high returns by taking manageable risks. You cannot avoid risk when investing in Equity but by having reasonable returns expectations you manage it at a level where you stay invested. 
 
You can build your equity portfolio by investing in:
  1. Direct Stocks
  2. Actively Managed Mutual Funds
  3. Index funds and ETFs
But all of them invest in stocks and hence knowing how that is done is fundamental to understanding why and how to invest in equity through the other alternatives. Everything that you have seen about investing in stocks is what an Actively managed Fund’s Manager-the person incharge of building and managing the mutual fund needs to do, albeit using their own methods, process and research. Investing in Index Funds and ETFs is simply choosing the universe of stocks eg an Index, and investing in all of them in the proportion they are  in the index or ETF. So, there is no Fund Manager making the decision on what to invest in. 
 
You can read more about the different types of Mutual Funds in this blog: Types of Mutual Funds
 
And to know the most important terms in MF investing , refer to this blog: Do you know the ABC of Mutual Funds Investing…
 
Each has unique benefits and challenges which you will understand better now that you know how to invest in stocks directly. This is summarized below:
 

Key benefits of investing in Stocks

Flexibility and Control

  1. Higher control over the portfolio.
  2. Can allocate more to a few stocks where investor/advisor has conviction.
  3. Decisions not impacted by external factors as in an MF eg large inflows, redemption pressure, fund manager exit, etc.

Lesser Cost

Lower overall cost compared to mutual funds.

  1. No fund manager expenses.
  2. Lower churn. Can enter and exit without impact cost (adverse impact on price) usually faced when order sizes are large.

Key Challenges

 

  1. Risk of capital loss
  2. Stock prices are extremely volatile in the short term leading to irrational investor behaviour.

 

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Key benefits of investing in Mutual Funds

Diversification

  1. Mutual funds typically hold 50 stocks in a portfolio thus less risky.
  2. An investor can benefit from multiple investment strategies and themes with ease.
  3. Actively managed by a competent Fund Manager

Small Ticket Size

  1. Investment in a diversified portfolio with a very small amount.
  2. Easy to follow a disciplined way of investing monthly savings.

Key Challenges