History has shown us that equities have been the most rewarding investment, asset class over long-term horizons. It has potentially generated tremendous wealth for investors. As more and more investors realise the potential and need for equities in their portfolio, they are faced with the choice of either investing directly into equities or investing through equity mutual funds. Which is better? What should I do? This article answers that question.

What do you need for direct stock investment?

1. Time to research stocks: Studying the share markets is a full-time activity and requires a lot of time and energy on part of the investor. You would also need to analyse economic numbers and macro-economic factors like government policy changes, global impact, currency, etc. You should probably leave your day time job /business to do that.
2. Market Expertise: One needs adequate skills and expertise in managing investments. Since too much information is readily available, true skill is to know what is important and to analyse the same and assess the impact on the stock prices. This is not which you can learn easily but comes only with experience, involvement and intelligence.
3. Research affordability: There are a cost and time factor involved in research and study. The time is something which carries huge costs but is unfortunately not often measures by small investors. Such costs are justified if your investment capital is small or if you are a small-time investor.
4. Unbiased and emotional control: It is a fact that a very large majority of equity investors haven't created much wealth from stock investing. Faulty investor behaviour is the culprit when it comes to less than optimum returns from markets even though the markets have performed very well in long-term. Can you claim to be unbiased to your stocks, remain unaffected from daily news and stock movement and not be carried away?

What you will not get with Mutual Funds investments?

1. Excitement and thrill (or worry) of stock movement: Let's admit it. Direct stock investment is exciting and thrilling. It is like T20 and if you wish to be always preoccupied with markets, like the excitement of uncertainty, direct stock investments may be your preference. Mutual fund investment would be like a test-match, it is boring and not exciting enough for you.
2. Full control over investments/stock selection: In mutual funds, there is someone else who is taking the stock investment decisions within the ambit of the scheme objective. You have no control if you want HDFC bank instead of a Yes Bank in your portfolio.
3. Ownership rights: With direct stock investing you become a part-owner of the company and get ownership rights. In a mutual fund, you do not get that sense of ownership since underlying stocks are 'indirectly' held by investors through the fund house.

But what you will get with mutual funds investments?

1. Professional management: In mutual funds, the investor leaves this task to the fund managers who are professionals in their field and manage the investment on behalf of the investors.
2. Portfolio diversification: With mutual funds, you have very good diversification. Even if a stock goes bust, you are not much affected. As opposed to this, if you had been invested in that stock directly, you would have likely suffered a huge loss.
3. Diversification at affordable cost: With just a few hundred rupees, one can invest in over 20-30 companies. This is because MF units have are priced at affordable NAVs derived from the entire portfolio. You may be owning highly priced stocks which may not be possible In direct equity investing, Also, such level diversification will not be easy to achieve in direct investments with low capital.
4. Economies of scale: Mutual funds enjoy great economies of scale for their entire research, fund management and administration costs. These are passed on the investors as the fund size or AUM grows in the form of lower expense ratios. Expense ratios are the only cost which the investors pay and it is clearly known in advance.
5. Investment management tools: Mutual funds offer many tools like SIP, growing SIP, STP, SWP, dividend payout, dividend reinvestments, insta cash, etc which can be smartly used by investors to manage their portfolio and cash-flows. Such multiple tools are not available at the disposal of direct stock investors.
6. Tax benefit: Of course, equity mutual funds enjoy similar tax treatment as direct stocks. However, equity-linked savings schemes or ELSS gets counted in your 80C investments. This benefit is not available in direct stocks.
7. Budget-friendly: For most of us, we are concerned with the investible surplus we have. With mutual funds, you can however relax and start saving with as little as Rs.500. There is no upper limit though.
8. Ready portfolios as per strategy: There is a huge choice of funds which follow different objectives and strategies in their preferred universe of stocks. There are ready portfolios like large-cap /mid-cap /blend /value /contra /sectoral or thematic fund, etc to suit one's risk appetite and strategy.
9. Choices for asset allocation: Moving beyond equity funds, there are funds offering every possible combination of equity and debt assets. Thus, even while you may be investing in a single fund, you may have a matching asset-allocation to your risk appetite. This is something you will have to manage separately in your portfolio.

To be fair, both mutual funds and direct equity have their pros and cons. What is more important is to know what you are looking for, what you are capable of and how much time and efforts you can put to it? Obviously, most of us are preoccupied in our lives, job, business, etc to devote quality time regularly only to investments, even assuming you have the necessary skills & knowledge. Investment in stocks is thus recommended only to those investors who not only are great researchers having expertise in markets but also willing to go put in the efforts. For the majority of us, mutual funds offer a much better trade-off where you can hire such proven experts in the industry for a small fee. When we look at the benefits offered, obviously we can safely say that equity mutual funds are the ideal vehicles for investing in stocks.

We as investors are mostly interested to know what returns I am going to get from my investments. It is seldom asked what is the real rate of return I am going to get.

It is very important to understand the real rate of return that is expected to come from one's investment rather than the absolute return which generally an investor ask for. To understand what you actually mean by the real rate of return and how it really helps in Wealth Creation you need to spare a few minutes to read through the article.

What is Real Rate of Return?

In simple terms, it is the return you earn above the inflation rate – which is the rate at which the prices, in general, are rising. To exemplify, if you invest in a fixed deposit which is today giving you a return of say 8% and the inflation is 6% then the real rate of return that you are generating would be 2%, ie., actual return (less) inflation for the period. The logic is simple – Rs.100 one or say 10 years ago does not carry the same value today because things have become costly due to inflation. Generally, consumer price Index growth (CPI) or wholesale price index growth (WPI) is taken as inflation indicators.

Having understood whats the real rate of return is, the question is how it is related to wealth creation. Let's understand what actually wealth creation means. Putting jargons aside wealth creation in simple terms is the increase in one's ability to purchase more things. If one feels his ability to purchase things have increased substantially over a period of time, one can simply say he has created wealth.

How can one increase its ability to purchase more through prudently investing?

That's a very right question to be answered. Let's go back to our example of one investing into fixed deposit with 8% absolute return and 2% real rate of Return. Say the investor had Rs 1,000 to invest in a fixed deposit. At 8% of interest rate, the value after one year of the amount invested would be Rs.1,080. Now assume that with Rs.1,000 he could have bought 50 packets of milk priced at Rs.20. Now with 6% inflation (assumed price increase of milk), the price of milk packet would be Rs 21.3 after one year.

At Rs 1080 available with the investor from his investment he now would be able to buy 51 packets of milk. The purchasing power of the investor has increased by one packet of milk thanks to the positive real rate of return. Had his return on investment been equal to the inflation he would still be able to buy only 50 packets of milk. And had his investment return lesser than the inflation, negative real rate, his capacity to buy milk packets would get reduced. That is the explanation why for creating wealth it is important to look at the real rate of returns and not the absolute returns on your investment.

Now interestingly let us look at the table below highlighting the approximate real rate of return across different asset class in India from 1981 – 2019. The question to ask is how it has increased the purchasing power similar to our example above over the period?

(Source: NJ Wealth – Internal. Assuming average inflation during period @ 6%.)

The results mesmerize us as to how the real rate of returns in equities over the period has increased the purchasing power and hence created wealth.

Never in the period considered had equities ever had a linear growth. There were many periods or phases when everyone considered to be the worst time for equity investors. For example, the equity markets in India post Harshad Mehta Scam (1994- 98) or post the Y2K technology bubble (1999-2001) or the after the Lehman brothers (2008-2012) and many such periods of dullness. But over the longer period, equities still delivered a real rate of return which increased the purchasing power the most as illustrated in the table.

Does the real rate of return increase the purchasing power over the shorter period say 5 Years?

The answer is NO. For a change in purchasing power, we require both time and returns.

What if we assume the same returns for the investor as return generated over 38 years to be generated in 5 years and measure the impact on the purchasing power?

There will be very marginal difference in the results and one cannot distinguish one from the other. Also, since equities are volatile in short-term, we cannot expect the same results of long term in the short term. That is not the nature of equities and something that everyone should understand.

Conclusion:

Equities change the purchasing power to a great extent and it been the biggest wealth creator across all asset class over a longer period, 10 years at least but longer the better, with the short term volatility. I would never understand why investor invests in equities and start seeing returns on a day to day basis and gets disturbed with short term negative returns. It is important to have a firm long term belief and give time to your equity investments for Real Wealth Creation through Real Rate of Returns from Equity Investments.

• Why are my returns low?

• Should I continue investing in current markets?

• What should I do to get higher returns?

These are some of the most common questions that we hear on the streets whenever the markets take a dip. Many investors who are new to the game are not really sure what is happening to the markets and to their investments. Are you having these questions? Have you been asked these questions? If yes, please read on...

What do I need to know?

Take a pause, clear your mind and go back to understanding the nature of the markets and the basic tenants of investing.

1. It is the nature of equities: So what makes equity exciting and rewarding as compared to a bank FD? It's because it is volatile in the short run with the potential to deliver superior returns in the long run. That is the basic nature of equities. It carries a risk which is not there in guaranteed investments. If you thought that equities deliver returns in a straight line, you are sadly mistaken. If you are investing in equities, you have to be mentally and financially prepared to take hits on your portfolio and digest even negative returns in short to medium term. If you cannot, I am sorry that you made a mistake of investing in equities. Please go back to guaranteed investments.

2. Why volatility is your friend: So it is clear that volatility is inherent in the markets due to many reasons. And it is because of this volatility that investors get opportunities to enter the markets, build on your portfolio and make strategic investment decisions (we will talk about it later). Without volatility, all the stocks will be fully valued to their (earnings) growth expectations at all times. In such a hypothetic and predictable market, everyone will invest in stocks and the advantage of equities over debt investments will no longer exist. It is only volatility that gives opportunities to investors and fund managers (mutual funds!!) to identify opportunities in the market to deliver 'alpha returns'. Alpha returns are the extra returns generated due to fund management expertise over and above market /benchmark returns.

3. Market timing is futile: Many studies have shown that equity market returns over the long term are fairly insulated from the short-term market volatility. In other words, your returns over say 10-15 years do not matter much whether you invest at Sensex 37,000 or 39,000. What would matter most is how long have you stayed investments. This is a fact and you can very well put your excel skills to good use finding out the extra returns you will get. In the end, the extra returns from market timing fall awfully short of the efforts, mental pressure and repeated transaction costs it carries. And this is only assuming that you are an excellent fortune teller who can predict how the markets will move. If you believe you can do that consistently over several years, you would be the first person in the world to do so and should be awarded a noble prize. No joking.

4. Asset Allocation strategy helps: So what should we do? Always remember that in investments, as in life too, often the simplest answer is the right answer. It is always the right time to go back to the basic tenant of investing – asset allocation. Yes. It is the time when you should do a proper relook at your asset allocation. It may be possible that your equity portion has reduced in size against your target. So realignment by moving some surplus funds from debt assets to equity to get back to the targeted asset allocation is what you can do. No rocket science here.

5. Investing in bear markets helps: Didn't we earlier say that falling markets provide an opportunity for investors to enter markets or invest more? Well, if you are a SIP investor, the news gets even better. All your SIP instalments being made in bear markets are surely getting you the much-desired boost to your portfolio. So do NOT stop your SIPs just because they may be delivering lower returns for now. Have patience and you will be suitably rewarded. Warren Buffet, the great investor once said that he will have absolutely no problems if the markets closed down for the next 10 years since his investment horizon is beyond 10 years. Take some time to ponder on this great idea.

6. Think discounts: Are you not excited every time Amazon or Flipkart offers great discounts? Don't you often end up buying new things which you do not even need just to benefit from these discounts? So why then do you think differently when it comes to dips in the market? Why can't you see that these are like discounts offered in the equity markets from time to time? Care to invest more now?

7. Losses are notional unless you make them real: Lets' get a bit philosophical here. No one can hurt you unless you allow them to hurt you. It's all how you think and feel from within that dictates your level of happiness and peace in life. The same philosophy holds very true for your investments as well. Your losses are notional and temporary. If you give them adequate time, they will recover and deliver decent returns over time. The market history tells us that the possibility of you generating negative returns from equity markets over say 10 years and above is almost nil, irrespective of all ups and downs during the journey. So just chill. Unless of course, you want to kick the axe yourself and enjoy losses by selling in panic.

Let us again reiterate some facts. Equities are risky in the short-term. They hold the promise of good real returns (above inflation and post-tax), more than any asset class in long-run. Short term volatility offers opportunities and is not necessarily bad. Stick to the basic idea of discipline, asset allocation, regular investing and time in the markets to enjoy better returns in the long run. Do not stop SIPs rather see if you can increase them. In case you still need help, just call your advisor for more gyan and assurance on the subject.