Although both forms of investments constitute “equity investments”, there are many differences which you as an investor need to know, to make an investment decision -
Management of Investment - As an investor in stocks, the decision of when, what and how much to invest in each stock solely lies with you. You need to constantly monitor your stocks, closely follow market movements which may affect your stocks and make your buy/sell decisions based on your individual judgement. Investing in mutual funds is much easier, as professionally qualified fund managers monitor the fund and buy/sell stocks in the portfolio.
Diversification - When you invest in stocks, your risk is concentrated, as your investments are restricted to a particular company or group of companies. At the most, you can diversify as per size or sector. Equity mutual funds are classified as per size, sector, maturity period, investment objective etc. Even within a particular fund, the portfolio is comprised of several companies which have their own risk-return profiles. Hence, your investment is diversified. Mutual funds can also invest in other asset classes like debt, gold or a mix of debt and equity. This is one of the biggest advantages of mutual funds.
Volatility - Individual investment in stocks is highly volatile as risk lies with a single stock. This may result in you taking rash decisions. Mutual fund investments are less volatile due to the number and variety of stocks in each fund’s portfolio, which largely smoothes out uneven movements. Stocks that move positively make up for the limitation of the stocks that have not performed so well.
Returns - Returns from investing directly in stock markets depend a lot on your knowledge, patience and time you dedicate. In a bull run, you can reap huge profits without much hard work; but in a bear run, the vice versa is also true, as stock market investing is riskier compared to mutual fund investing. Mutual funds give you balanced returns, compared to stock markets (neither as spectacular as stocks in a bull run, nor as unimpressive as stocks in a bear run). Returns from mutual funds basically mirror stock market returns.
Mode of Investment - You can invest in a mutual fund, either a lumpsum, or as a systematic investment plan (SIP), making periodic investments. The SIP mode is highly recommended for long term and can be adopted even if you do not understand equity markets. You can try and follow SIP in stock investing also; but since there is no diversification of risk, this is not a very smart idea and is hence not popular also.
Taxation Benefit - Short term capital gains and long term capital gains follow the same treatment, both in the case of stock investments and equity mutual fund investments. When you invest in stocks, you do not get any tax benefits. However, you can get tax benefits when you invest in Equity Linked Savings Scheme, which is an equity mutual fund with a lock-in period of 3 years. You can avail tax benefits under Sec 80(C) up to an amount of Rs. 1,00,000/-
Stocks and equity mutual funds belong to the same asset class - equity, which, compared to other asset classes give the best returns in the long term. If you are a retail investor with limited time and knowledge about stock markets, the mutual fund is a better channel to invest in the equity markets.