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Should I dump those boring stock funds for a handful of shares in a few zesty companies?- Hasn’t this question arisen in your mind when you have decided to go in for equity related investments. Especially when you see share prices moving selectively, or moving slowly-then this question assumes even greater importance. Who wouldn’t like their investments to be on the fast track of return - and it is pretty clear that the movement in stock prices is  reflected in the corresponding funds after a time lag and with the fund expenses taken care of. So wouldn’t it be better to just go in for the scrips you fancy rather than cushion investments through funds which have them in their portfolio?

The answer is no, sort of.

First of all you have to understand that stocks and stock funds are not mutually exclusive. As traditionally advised by investment counsellors-bulk of your core, long-term investments ought to be in stock mutual funds, but you can also include a handful of individual stocks to gain hands-on investment experience and maybe some additional long-term growth. Investors interested in taking the plunge into the stormy waters of equity markets should first have a firm grasp of their risk tolerance and investment objectives. Then they need to reassess the advantages of both stock and fund investing on parameters like diversification of risk, low cost entry, less homework, control, size, tax planning etc.

When it comes to diversification - definitely funds have an advantage over shares. The ability to invest and maintain a broad mix of stocks, without the enormous expense of brokerage trading fees, is a mutual fund’s raison d’ EAtre. Most fund prospectuses add their own diversification and investment-style requirements that increase the number of stocks the fund must hold. You can be fully diversified by owing just four five funds. Compare this to the fact that stock investors must hold a dozen or so blue chips spread among different industries to give them the full benefit of large-stock diversification. With small companies, however, there's safety in numbers. You may need as many as 35 to 40 stocks to provide enough diversification.

However when it comes to costs - stocks have an advantage. The most efficient way to invest from an out-of-pocket point of view is to buy individual stocks and hold them for the long term. If you buy and hold, that’s a one-time rather than annual expense. This is where your risk tolerance comes in. If you get jittery and trade too often, these rock-bottom commissions will add up, possibly eclipsing what you’d pay in a fund.

But when it comes to choosing which stocks to buy, the burden of stock research and portfolio maintenance is squarely on your shoulders as compared to when you invest in funds where the fund managers do the homework for you. If you want professional advice, you will need a full-service broker who’ll charge much higher commissions. A big chunk of those fund fees pay the salary of a professional fund manager who’ll analyze the corporate financial statements for you. There is one important caveat here, and that is first-hand or special knowledge of a company or industry. Hoteliers know the best hotels and Internet junkies know the best online companies. Buying shares of firms that you have an intimate knowledge of, may give you one up on the pros.

Asset allocation or choosing the appropriate mix of stocks, bonds and cash is the most important decision an investor can make and here funds definitely have an advantage over shares. Studies have found that asset allocation has a larger impact on overall long-term returns than stock selection or market timing. Four stock funds may be all a long-term investor needs: a large-company growth fund, a large-company value fund, a small-company growth fund and a small-company value fund.

However one problem with funds is that once they become successful, they have too much money to invest and end up owning too many stocks. As they keep growing they begin to mirror the return of the index they are trying to beat. One solution is to pick a few stocks that look like winners. Holding a small number of stocks is known as concentrated, compact or focused investing. Experts recommend using this investment strategy for no more than 20% of your long term investments.

Also if you are a control freak and like to closely monitor and control your investments perhaps funds are not your beat. It is hard to keep up with what companies you are investing in with a fund. A stock fund might own shares in Infosys one day and HCL the next. When you’re doing the picking, you know exactly what companies you own and how long you have owned them. The more a fund manager buys and sells stocks, the higher the fund’s turnover rate. A portfolio turnover of 50% means the manager trades half of the assets in the fund annually. High-turnover funds are sometimes at a disadvantage because they incur more brokerage commissions. These costs hit investors in the form of lower returns.

Funds are run by people and sometimes those people move on to greener pastures. But when fund managers walk out the door, their fund’s excellent performance walks with them. Investors have to wonder if the new manager will follow in his or her predecessor's footsteps ...or stumble.

Last but not least is the risk factor. Shares provide you with little or no cushion as you have to exit when the prices start plummeting. As compared to this the diversification cover that funds offer you holds in good stead in times of a choppy market.

So, there are no hard and fast rules-though funds are probably better for the longer term, there is no harm in handling a couple of sure shots you are confident about.

Aru Srivastava

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