Earning entities (i.e., profit making businesses and earning individuals) are always looking at investment avenues for their extra money. There are a wide variety of investment opportunities available including debt-based instruments such as fixed deposits and bonds to equity share investments to hybrid instruments. Earning income on investments balanced with safety of invested money are generally the key criteria for selecting the investment type.
This article looks at meaning of and differences between two types of popular investment modes – mutual funds and shares.
Definitions and meanings
Mutual funds
Mutual fund is a collective investing mode wherein funds are collected from several investors and are invested across securities of different companies. These securities can be shares or debt instruments of the companies. Mutual funds are operated by asset management companies and managed by assigned fund managers.
An investor can invest by purchasing units of mutual funds. In this manner they are able to participate in the capital or debt of different companies across categories and sectors. The units are purchased at their current market value – termed as net asset value (NAV).
Mutual funds can be of several types. One of the key classifications are – equity, debt and hybrid mutual funds. Equity mutual funds invest predominantly in shares of companies, debt mutual funds invest predominantly in debt instruments issued by corporate and government bodies, whereas hybrid funds are a combination of both equity and debt mutual funds.
Return to investors depends on the option of mutual fund selected – dividend or growth option. Dividend option involves payout of income to their investors whereas growth option reinvests the income in the fund itself providing capital growth to its investors.
Shares
Shares represent part ownership of a company i.e., an incorporated entity. Each company’s capital is divided into specified number of units of specified face value. Each individual unit represents proportionate ownership of the company and are termed as shares. Shares form part of equity mode of investing.
The value at which shares are originally denominated is the face value. Investors however, can purchase shares of companies at a higher or lower price i.e., current market value of the shares.Shares can be bought either through stock exchanges (in case of listed companies) or off-market through sellers (in case of non-listed companies). By purchasing shares of a company, investors get to participate in the profits of the company.
Companies who have issued shares can declare dividends to its shareholders if they have surplus profit. Investors can thus earn income in the form of dividends from shares. Additionally, the value of shares can increase or decrease depending on the financial performance of the company. This way investors can also earn capital gains income from their investments in shares.
Shares can primarily be of two types – equity and preference shares. Preference shares get priority over equity shares with regards to receipt of dividends and receipt of proceeds in case of liquidation. Equity shares are regular shares that are prioritized after preference shares.
Difference between mutual funds and shares
The difference between mutual funds and shares have been detailed below:
1. Meaning
- Mutual funds are pooled investment schemes which invest funds across asset types – including both debt and equity.
- Shares are investment units that provide part ownership in the issuing company to the holder, which allows for profit participation.
2. Components
- Mutual funds can invest in both equity and debt securities – they can thus comprise of both equity component as well as debt component.
- Shares form part of the capital of a company and thus comprise only an equity component.
3. Diversification
- Investing in mutual funds offers diversification as it invests across different companies possibly across different sectors as well.
- Investing in shares of a single company offers no diversification as the investment is confined to one sector and one company within that sector. Diversification can be achieved by investing in different shares.
4. Risk levels
- Due to high possibility of diversification, risk associated with investing in mutual funds can be lower.
- Due to limited diversification, the risk of investing in shares can be higher.
5. Issued by
- Mutual fund units are used by financial companies – asset management companies.
- Shares are issued by individual companies across different sectors.
6. Dividend returns
- Mutual fund unit holders may or may not receive dividend depending on whether they opt for dividend or growth option.
- Shareholders receive income in the form of dividend, when declared by the company.
7. Investment management
- Investing in mutual funds involves passing on investment management function to fund managers of the mutual fund.
- Investing in shares requires self-management – in deciding which shares to be selected.
8. Expertise required
- Investing in mutual funds on the other hand requires minimal expertise as the investing strategy is managed by expert fund managers.
- Investing in shares requires significant expertise as the investor is required to study the market and the companies to identify lucrative shares investing opportunities.
9. Rights of holders
- Investing in mutual funds does not offer voting rights in the individual companies, to the unit holders.
- Investing in shares offers certain direct rights to shareholders such as voting rights.
10. Types
- Mutual funds are primarily of 3 types based on its investment portfolio – equity, debt and hybrid.
- Shares are primarily of two types – equity and preference.
Conclusion – mutual funds vs shares
Choice of investment between shares and mutual funds would depend on the investor’s risk appetite and investing knowledge and expertise. If an investor has higher risk appetite and wishes to apply his investing expertise to earn higher returns he can opt for shares. On the other hand, if the investor prefers to hand over his investment management to experts, he can opt for mutual fund investing.
