When you buy stock in a company, you own a part of the company. However, when you buy a mutual fund, you don’t own anything of any company, but you have exposure to several instruments with one investment.
Let’s understand that with an example. Keep reading.
We all have preferences for snacks. You tend to buy the one you like the most from the nearby Kirana Store. And you do buy in bulk sometimes.
Then there are some people who visit the supermarket and pick a pack of five or six. The supermarket bundles a few flavors together and sells them because some people want variety in their baskets.
The single flavor is a stock, and the bundle is a mutual fund. Not to worry, we will dive deep to give you a better understanding.
- What are stocks?
- Different types of stocks
- What is mutual fund?
- Types of mutual funds?
- Difference between mutual funds and stocks
- Quick Summary
What are Shares?
A share is nothing but a part of the ownership of the company issued to the general public to raise capital. So, when you buy shares of a company, you become the owner of that company proportional to the value of the shares. Whoever owns the largest amount of shares is the owner of the company.
Buying shares gives you an equal right to profit and loss of the company. If the company’s value rises, you will get considerable capital gains.
Now you might be wondering why an investor would want to buy shares of companies ?? and why would a company put out shares to sell.
A company may put out shares to sell for any of the following reasons:
- To pay off debt
- To launch new product
- For company expansion
- Meet some expenses
- Invest in Research and development and many more…
Investors would buy the shares for the following reasons:
- For long-term investment
- For intraday trading (Learn about intraday trading, here)
- To have some equity exposure in their portfolio. (Learn about stock market portfolio, here)
- To have some voting influence in the company (those investors who can buy a significant amount of shares) and several others…
Types Of Shares
Simply going onto the stock market and buying shares isn’t all about it. There are more facets to shares. For instance, what kind of share you are buying and what it means for you as an investor.
Here are the types of shares and what they mean:
Common or Equity Shares
Common shares, equity shares, or ordinary shares are the same things. The majority of shares issued by the companies are equity shares. They are the most commonly traded ones on the stock market.
Now, the investor who owns common shares has voting rights in the company. The owners of common shares are also entitled to dividends declared by the company. However, common shareholders receive dividends after the preference shareholders.
As the name suggests preference shares have preferential benefits compared to other types of shares. They get dividends before the common shareholders. They will be paid first in case the company goes bankrupt after settling the debts of the creditors. But they do not have voting rights.
Learn the difference between Equity Shares and Preference Shares.
Differential Voting Rights Shares (DVR)
The differential voting rights shareholders have fewer voting rights than equity shareholders. Companies can dilute voting privileges. In such cases, companies provide extra dividends to DVR shareholders. It is important to note that the prices of DVR shares are low since their voting rights are low.
What Are Mutual Funds?
A mutual fund is a pool of securities such as stocks, bonds, and short-term debt. Asset management companies sell mutual funds. Each mutual fund has a fund manager managing it.
This fund manager is a financial professional who manages the pooled investment.
A mutual fund helps investors to have exposure to various instruments. Since a mutual fund has units of various instruments, an investor investing would get proportionate units of all these instruments. Example: A mutual fund may consist of a stock, a bond, a debt instrument, etc. Now an investor putting up some money in it would get certain units of each of them.
Mutual funds stabilize the investment. While one instrument may be risky, a more stable one would be less risky and balance out the volatility of the whole fund. This is what a fund manager takes care of.
Types Of Mutual Funds
There are broadly three types of mutual funds operating in India — Equity funds, debt funds, and balanced mutual funds. They are categorized on the basis of their asset allocation. Let’s understand each of them.
Equity Mutual Funds
As the name suggests, equity mutual funds invest in equity shares of companies. If a mutual fund invests at least 65% of its portfolio in equity instruments, then it will be categorized as an equity mutual fund.
Although the returns of equity funds do depend on a variety of factors like economic situation, global sentiment, etc., it provides the highest returns among all types of mutual funds. Some examples of equity mutual funds are listed below:
- Small-Cap Funds
- Mid-Cap Funds
- Large-Cap Funds
- ELSS Funds
- Index Funds
Debt Mutual Funds
Debt mutual funds invest in fixed-income instruments, money markets, debts, treasury bills, government bonds, etc. Any mutual fund with more than 65% of investment in debt instruments is categorized as a debt mutual fund.
Since a debt fund comprises fixed-income instruments, it is good for risk-averse investors. The performance of the fund is not much impacted by the movement of the market. Some debt funds are:
- Dynamic Bond Funds
- Income Funds
- Liquid Funds, etc.
Some funds invest in both equity and debt instruments almost equally. Such are called balanced mutual funds. The portfolio of such funds is very diverse, and it balances the risk-to-reward ratio.
The fund manager of a balanced mutual fund allocates the assets on the basis of the market situation to give the best returns to the investors.
Some examples are:
- Equity-Oriented Hybrid Funds
- Debt-Oriented Hybrid Funds
- Monthly Income Plans, etc.
Difference Between Shares And Mutual Funds
- When you buy a stock of a company, you own a part of the company. However, when you buy a mutual fund, you don’t own anything of any company, but you have exposure to several instruments with one investment.
- While you can buy and sell stocks multiple times in one session, you can’t do the same with mutual funds.
- For diversity, you need to buy stocks of diverse companies, but buying a mutual fund brings diversity automatically.
- Stocks are volatile, meaning the prices can move within a matter of minutes. Mutual funds absorb the sudden volatility, and their diverse nature softens the blow.
- Stocks can give you positive results in a very short time. Mutual funds need to be kept for at least a few months to a few years to realize good returns.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:
It is not right to say that one is better than the other. Because both mutual funds and stocks have their merits and demerits. However, a good investor needs to have both mutual funds and stocks in his/her portfolio. After all, both are instruments of investment and both serve the purpose of making you money.