Should I invest in stocks along with equity mutual funds?

Published: November 30, 2023 at 6:00 am

A reader says, “I have invested in equity mutual funds for the last two years. Should I also invest in stocks?”

This is a question that only the investor can answer, but we can provide some guidelines. Why do you want to invest in stocks? Is it because you heard multibagger stories on social media and feel you are missing out on something? Or did you read someplace, or did someone mention that stocks would do better than equity mutual funds (index fund or active)?

If this is the case, and I am afraid it often is when the tone of the question is as above, then investing in stocks is a terrible idea. Here is why:

  • At best, you would want to invest only a tiny portion of your portfolio in stocks, but that would require significant time* to research and invest. That time and effort are almost always better spent on upskilling and increasing income. We need money to make money. A lack of capital cannot be compensated by higher risk.
  • *Note: I maintain a “lazy stock portfolio”, which started only after I reached financial independence. When you are in the early stages of accumulation, the pressure is much higher, and so is the risk. So you are unlikely to make reckless decisions like I have done.
  • Young stock investors chase after mid and small cap stocks hoping to strike it big. This results in significant churn, costs, taxes and pain.
  • Stock investing requires oodles of conviction and clear-headedness, which is rare to the point of extinction. This can be learnt but will cost time and money, which most people do not have.
  • A stock portfolio is inherently more risky than a mutual fund portfolio due to concentration risk. This can result in big rewards occasionally, but very few investors have the maturity to quit while they are ahead and book some gains.
  • More often than not, this concentration risk results in risk! Young people argue that they have time to time to bear the risk. To some extent, this argument is just about acceptable if the money is in an index or active fund. But a market recovery need not mean your stock portfolio would recover.
  • Most investors are scared to benchmark their stock portfolios. They might be shocked if they did – we have just the tool to do this for MF and stock holdings. Often all that effort and time spent on social media “following” people who flaunt their holdings may not be good enough to beat the index or an index mutual fund. They then claim that stock investing is their “passion” and are willing to suffer through bad patches.

This is what we recommend:

  • If you genuinely enjoy researching business models and value holding a small slice of companies, then by all means, start a small stock portfolio. However, all decisions should be based on your research, not social media trends. If you are unwilling to do this, avoid direct equity.
  • In any case, never work with the assumption that your stock portfolio will do better than an index or your MF portfolio. No one knows what the future holds, and that is the risk you take. Just don’t take it with too much money!
  • How about curated stock baskets? They are even riskier and more expensive than a DIY stock portfolio.  Do not get enamoured looking at those backtests. Avoid!
  • Ensure this DIY stock portfolio is a small portfolio of your total equity portfolio. This is also known as a satellite portfolio. Treat this as a hobby. Buy established businesses with low debt first and learn the ropes. Then you can dabble (just a little) in mid and small cap stocks.
  • Enjoy nurturing a stock portfolio without the pressure of financial independence or goal-based investing.
  • Remember, no one will give you an award for being a stock investor, value investor, or momentum investor. All we need is money for our needs. A simple index fund with ample systematic investing will get that job done. If you still want to be an active investor, start small and stay small.
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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 ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), 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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