Investors in equity mutual funds have the flexibility to redeem their investments anytime as per the current NAV. In contrast, investors in individual stocks face uncertainty regarding the availability of fair market prices when they decide to sell their shares.
There are several ways to grow your wealth using the capital markets. Most individuals invest in stocks directly, i.e., direct equity or via mutual funds, also known as equity funds. Direct equity enables you to directly purchase a stock from a company where you own every share bought, along with privileges like voting rights. On the other hand, equity funds invest the accrued funds from investors in publicly traded stocks, referred to as mutual funds.
In this article, we will explore the key differences between direct equity and equity funds, which will allow you to make informed investment decisions.
What is direct equity?
As the name suggests, direct equity involves investing in the stock market directly, where the investor receives the company shares. In simple words, a share is an indivisible unit of capital that represents the investor’s ownership in the company as well as the voting privileges. Investment in the capital market is open to all participants.
During the trading hours, you can witness the stock price fluctuations. For example, if you invest in a stock that is lucrative, the stock price might rise. Consequently, you will also generate profit on your direct equity investment. However, you must note that this is not always the case, as there are several factors that impact the price movements in the market.
Investing in direct equity is quite straightforward. You are required to set up Demat and trading accounts for the purchase and sale of the shares. If you wish, you can personally oversee the activities of your demat account or hire a broker or dealer to assist you. Investors who have a profound understanding of the market conditions and economic dynamics generally buy stocks directly from the capital market. Such participants also have a nuanced understanding of their risk appetite and profit potential. Those who do not have sufficient time or knowledge to gauge the market influences should rely on expert advice while making direct equity investments.
What are equity funds?
Mutual funds are open-ended funds, where the money accumulated from the investors is invested in different stocks. Essentially, a mutual fund invests in stocks on the investor’s behalf. The scheme’s objectives decide the percentage of equity asset allocation. On the other hand, the NAV (net asset value) of the equity fund vacillates depending upon the market conditions. Here the NAV is the price for the equity fund investment.
The most prominent advantage of investing in equity mutual funds is expert fund management. In this setup, the fund managers are responsible for deciding which assets to buy, sell, or retain. Plus, investors enjoy liquidity as well, where they can choose to withdraw their money anytime. Most equity funds are designed to fit the investor’s goals and risk appetite, so there are options for all kinds of participants. Lastly, the biggest advantage among all is that you do not need a large amount of capital to invest in mutual funds. You can simply begin with a minimum investment value of Rs. 500.
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Difference between direct equity and equity funds
The following pointers will help you understand the key differences between direct equity and equity funds, enabling you to make a more informed decisions while investing.
1. Professional management
Investing in direct equity requires robust economic knowledge and sharp intuition, which every investor may not possess. Conversely, equity funds are professionally managed by financial experts so that investors who do not have the time or inclination to research can still find a way to invest and grow their wealth.
2. Volatility
Compared to individual stocks, equity funds are more stable due to their ability to diversify across industries and companies. Individual stocks are volatile, which can lead to massive profits or losses. Read more about, Market volatility.
3. Risk
The high volatility of individual stocks makes direct equity riskier than mutual funds. Moreover, equity funds have risk mitigation guidelines to ensure fund managers do not hyperfocus on a particular stock. Read more about, Risks in mutual funds.
4. Expenses
With direct equity, investors have to incur charges related to opening and maintaining the demat account along with trading charges like STT (Security Transaction Cost). On the other hand, mutual funds levy service fees for managing the investor’s portfolio.
5. Liquidity
Investors can withdraw their funds from mutual funds at the existing NAV at their convenience. In the case of direct equity, depending on the conditions, there may or may not be a fair value for selling shares. At times, the investment value of some stocks could also drop to negative numbers. Read more about, Liquidity in mutual funds.
6. Investment amount
The amount of funds invested in direct equity depends on the prevailing prices of individual stocks. Expensive stocks might deter small investors from participating. Conversely, mutual funds allow investors to invest as little as Rs. 500. Moreover, they can pick a SIP to invest in a more consistent and disciplined fashion.
7. Tax
The tax implications for both direct equity and equity funds are similar. Holding periods less than a year provide short-term capital gains, which are subjected to a 15% tax rate. Long-term capital gains over Rs. 1,00,000 are taxed at 10% sans indexation benefits. Likewise, when investors put their money in an ELSS fund (a form of equity fund), they qualify for a tax deduction listed under Section 80C up to Rs. 1,50,000 of the Income Tax Act, 1961.
Understanding the differences between direct equity and equity mutual funds with an example
Suppose Mr. A has a profound understanding of the financial markets and has honed his business acumen and economic policies over the past few decades. He knows how to analyse a company based on past and current returns, overall financial health, scope for future expansion in their respective industry, dividends, leadership, and more. Likewise, he has enough time to keep an eye on every price movement alongside influential factors such as news, government policies, and competing stocks. Based on this information, we know he is an ideal candidate for direct equity as he has the experience to invest directly in stocks and knows what works best for his fiscal goals.
Mr. B, on the other hand, is a busy professional and is new to capital markets but is enthusiastic about investing. However, since he has little to no interest in financial markets, he is not too eager about actively monitoring the stocks. He also feels uncertain about the direct equity volatility and wants to undertake the lowest possible risk. This is why he is the perfect candidate for an equity fund which is managed by a financial expert. All he needs to do is pick an equity fund (small/mid/large-cap) based on his budget and the sector he finds to be the most fitting.
How to decide between direct equity vs equity mutual fund?
Investing in direct equity makes sense for those who have extensive knowledge about stocks and market behaviours as well as have enough time on their hands to manage them. Equity funds, on the other hand, are great for investors who want their investments to be professionally managed and expertly diversified without needing their constant intervention.
Factors to consider
- Knowledge of equities
Take some time to understand how well you know the markets and your aptitude to scrutinise businesses and investment opportunities. - Behavioural tendencies
If you struggle with active management or are not disciplined enough to overlook stock investments, it is best to leave it to the experts by opting for mutual funds. - Schedule
Direct equity requires your time and attention. So, if you can comfortably monitor stocks on a routine basis, only then should you consider direct equity investments. - Long-term goals
Both investment strategies will yield long-term results, so choose the one that fits your schedule and financial goals effortlessly.
Which one should you choose between direct equity and equity mutual fund?
Both direct equity and equity funds have their own sets of advantages and disadvantages. What one chooses is entirely dependent on their discretion as an investor. You can refer to the following table to gain some clarity.
Direct equity makes sense when you |
Equity funds makes sense when you |
Have a comprehensive understanding of the markets, trends and policymaking. |
Have superficial or zero understanding of the market and businesses. |
Have adequate time to personally assess the performance of the stock. |
Have no time to personally monitor the stock and its price movements. |
Have experience investing directly in stocks and diversification. |
Have little or no experience in stock investing. |
Have a robust risk tolerance. |
Are risk averse. |
Have contingency plans when unexpected situations occur. |
Lack additional funds to organise contingency plans. |
Conclusion
There are various differences between direct equity and equity funds. While direct equity demands a thorough grasp over market mechanisms and industry trends, it can also be rewarding if you are willing to stay in the game for the long haul and can quickly adapt to emerging market conditions. Alternatively, equity funds are a better match if you have limited time, capital, or both to dedicate to stock market endeavours. All you have to do is choose mutual fund schemes that align best with your financial goals and give you enough flexibility to jump in or out of an investment.
