Differences between Direct Equity, Mutual Fund and Indexed Fund Investments

Last Updated at: Oct 27, 2020
Many mutual fund investors have been taking keen interest in passive schemes lately. This is because of two reasons: so many people are speaking about passive strategy and the track record of passive schemes in the last couple of years has been impressive.


We know that all transactions in the financial market are subject to risk and we can almost recite the precautionary warning at the end of every advertisement ‘Please read offer document carefully before investing’. But most of us inevitably fail to read long and boring offer documents, and out of the rare segment of us that do, financial jargon is enough to dissuade. This post is aimed at helping you understand the basic nuances of differences between three common market instruments – direct equity, mutual funds, and indexed investments, to be better informed of where to park your investments.

Direct Equity – Getting your share of ownership of the company
When we invest in the equity shares of a company, we are, in legal terms buying the ownership of the company. The total amount that a company plans to raise is divided into small fractions called shares, which have a value in rupees. By subscribing to these shares, we get a right to participate in company meetings and voice our opinion on decisions but the real reason why we invest, is to earn divided – which is like a reward to us an investor, because it is using our money that the company earns a profit, which is now distributed to the owners in the form of dividend. One can also choose to give up the shares – back to the company or sell it to a third party for a premium.

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Mutual Fund Investments- The charm of professional investment and less risk
Mutual funds arose an alternative to investment in equity because most investors neither had the time nor the acumen to monitor stock trends or be updated with the latest financial news to keep their investments optimum. Thus, mutual funds found their roots in this sentiment and encash on engaging professionals who manage our investment. It is these trained people – often called portfolio managers, who decided which shares to invest our money into. Since it is professionally done, the mutual fund earns on the basis on the gains made and may also charge a regular fee.

Mutual Funds and Equity – The Yay and Nay

The best advantage of a mutual fund over equity is that there is reduced risk, since most mutual funds seek to invest in multiple stocks of different companies, bringing the overall exposure to risks down (As the loss in one may be set off by gains in another). However, the risk that prevails is that sometimes the entire basket of investment may not do well.

A disadvantage of mutual funds is that as indirect investors, we may not have the freedom to withdraw money from a specific share as is possible in the case of individual investment in equity. Moreover, all gains are the shareholders with no sharing arrangement with anyone. Thus, for a higher risk exposure, there is a greater reward in equity.

Index Fund Investments – Driving the car from the backseat
This investment is ideal for those who want very low-risk investment portfolios with decent returns. It is known as a passively managed fund, as the portfolio manager seeks the equity of companies listed on a benchmark like Nifty. These track a particular index like Nifty or Sensex, and efforts are made to match the returns to that of the index. Since it is a basket of companies with established performance benchmarks, there is less risk and the monitoring is easier. They are also less expensive as the outlay in terms of costs is less due to the almost mechanical tracking of indexes.

The disadvantage of this investment over equity or mutual fund is that an investor may lose out on cashing in on huge market returns that may be possible by active investment by mutual funds or individual investment in equity.