Can I get better returns from stocks instead of equity mutual funds?

Published: February 21, 2021 at 10:37 am

A common question that troubles several investors, particularly newbies, is, can I get better returns from stocks instead of equity mutual funds? Many feel like they are missing out on better returns by staying away from stocks. They feel like they need to have at least “some exposure” to stocks—a discussion.

A while ago, I addressed an investor club, and no one there was above the age of 22! Many of them found it odd that I took to investing in stocks rather later, and it is only a small portion of my portfolio. One member asked me the question that led to this article. Most of their previous meetings were about stocks – how to choose them, how to value them etc., and the obligatory how to trade in crypto sessions.

To the typical young investor, picking stocks for the long term may not be as cool as crypto or general trading. Still, it is definitely more fashionable than investing in mutual funds. Let us get right to it lest I lose their attention: There is no way of knowing or answering if one particular stock portfolio can beat one particular mutual fund portfolio.

So the answer to the titular question: We do not know; we cannot know. That is if you value an objective answer. If you want opinions or what people believe is more likely without data, you need to look no further than this article’s comments on social media. The rest of this article is about why we cannot know.

First, take the case of active mutual funds vs passive mutual funds. If we wish to know how active mutual funds have fared against the “market”, a study such as this is possible: Active mutual funds struggle to beat Nifty 50 for the last seven years!

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    If we wish to know whether the situation will continue in future, there is no way to predict. Still, a reasonable assumption is possible: active funds will go through periods of underperformance and outperformance (wrt to the index), and when viewed collectively, we can assume not much is going to change.

    If we wish to know whether X active fund or Y active fund will beat the index in the future, then even this reasonable assumption cannot be made. To borrow a line from Asterix, maybe they will beat the market, maybe they won’t; I can’t say for sure.

    Why? Because we are considering a single stock portfolio. Its past performance is quantifiable, but no one can predict one particular fund’s future performance – not even a passionate index fan.

    Now take the case of real estate. If you ask, “over the last ten years, which has done better in India” stocks, gold or real estate?” The answer is, “we do not know”. The past performance of stocks and gold can be quantified, but not real estate. It is extraordinarily location-dependent and people-dependent.

    There is no real estate index to compute trailing returns or rolling returns – at least no index that reflects ground reality. We only have useless anecdotal evidence: “my uncle made 3X profit in ABC locality.”

    Forget the future. There is no proper way to analyse the past when there is no quantifiable data. This is the exact problem with individual stock portfolios. A person can create a stock portfolio in a zillion ways; They can change it over the years in a zillion ways.

    They can compare their portfolio with an index – see, for example, My Stock Portfolio Feb 2021 – but that one cannot use the results to judge about stocks vs mutual funds.

    Sure there is plenty of opinions on the matter – the loud voices are often from those with a conflict of interest.

    • Stock picking takes hours and hours of effort.
    • Managing a stock portfolio is hard.
    • Even professionals have trouble beating the market etc.

    The root cause of the problem is trying to take sides when one cannot. The reality is, mutual fund investing is no easier than stock picking. Most investors cannot decide which fund to pick, which to sell or how to construct a portfolio. Many of them hold so many funds that it resembles the market with expensive fees.

    Both direct equity and stock picking requires focus, conviction, discipline, appreciate of risks – identical traits. So, where is the problem?

    Taking sides when one cannot: Many feel a stock portfolio will do better than a mutual fund, and all they can offer as evidence is theory like “how a fund manager is constrained by money pooling”.

    Many others feel direct equity investing is harder and bound to fail because most investors do not know how to pick stocks. Stay long enough in a personal finance forum like Asan Ideas for Wealth, and you will recognise that most investors are clueless about mutual fund investing.

    Want to believe what we do is best: Many of us need to think our choices are the best and bound to do better in future. This is like asking, “I am getting married tomorrow. Will it work?” The only truthful answer to both: We do not know.

    So what is the solution? Embrace our inability to know the future (and brace for it!). One can happily invest in stocks and mutual funds in any proportion we like. Only you can decide what is right for you.

    Which is better? As they, “I guess we will have to find out!” You will know only by spending time and money.  The experience is guaranteed. The higher or lower return is not.

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      Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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