Buying stocks, MFs? Read this first

Investors often face this dilemma -- should they invest in equity (stocks) directly or should they opt for the mutual fund route. The answer to us is pretty simple, really. However, for starters, let us examine the various costs involved in adopting any one route.

Comparative Analysis between Equities & MFs

If you compare the two avenues, item by item, you will find at least on the cost front, both are more or less even:

1. No brokerage for mutual funds either on purchase or on sale. This is more than offset by the entry/exit loads and AMC fees of mutual funds.

2. No Securities Transaction Tax for mutual funds during purchase. This is compensated by double the STT at sale.

3. Mutual funds are exempt from Dividend Distribution Tax (DDT) of 14.025%! But let us not get lured by this. DDT is charged to mutual funds when they receive dividends on the shares they own in the portfolio. Charging DDT to you when you receive the dividend from the mutual funds would be double taxation.

So this brings us back to square one. What does the investor do?

As mentioned in the beginning of the article, the answer is simple and it doesn't depend upon the expense or the tax structure -- instead it depends upon you.

There are more than 5,000 stocks out there out of which around 2,500 are actively traded. If you know any of these 2,500 stocks in detail -- that is, if you understand the business dynamics and the prospects of any industry and the companies within that industry -- then by all means you should invest directly.

For example, a friend of ours works with a pharma company. He has had decades of experience within the industry and knows the positives and negatives of each company within the industry fairly well. He would be a fool to waste such knowledge, thus very appropriately most of his stock investments are in the pharma sector.

Incidentally, the returns on his portfolio beat any pharma fund hollow. However, for exposure to the rest of the industries in the economy, he opts for the mutual fund route. Needless to add, his portfolio is thriving.

Similarly, one may be working in the auto, cement, engineering or even IT, use your inside knowledge -- and by inside knowledge we don't mean inside information, we mean use your domain expertise of your industry -- to invest well. Do not touch any stock that you don't know the business of too well.

Look at it another way. When you have a health problem you go to a doctor. Similarly a legal problem is solved by the help of a lawyer. These are domain experts in their own field and one recognises them as such and uses their professional guidance.

Similarly mutual funds and their fund managers are domain experts so far as the stock market is concerned. Just as you won't self-medicate or fight your own case in court, do not try to do the fund manager's job yourself. It is the fund manager's business to understand other businesses and you should take advantage of the same.

Now take a look at the following table:

The above is a representative sample of the domain experts in the field. There are many such schemes: this is just an example. Now ask yourself honestly -- has your individual foray in the stock market resulted in such returns? The answer lies in the question itself.

In any case, when it comes to the stock market, never trust anyone but yourself. Never ever depend upon tips and hunches. Do not self-medicate. Otherwise, you will neither be a bull not be a bear, but you definitely will be a bakra.

The writer is Director of A N Shanbhag NR Group, a Mumbai based tax and investment advisory firm. He may be reached at sandeep.shanbhag@gmail.com