When it comes to investing in stock markets, an investor is exposed to two kinds of risks – systematic risk and unsystematic risk. Systematic risk is due to macroeconomic movements and it affects the whole market, while unsystematic risks are company specific risks.
When we buy a stock of a single company we are exposed to both systematic risks (market risk) and unsystematic risks( company risk. But when we buy a diversified mutual fund or a portfolio we are exposed only to systematic risks and there is no unsystematic risks due to proper diversification by the mutual funds.
Let us take a look at some of the major advantages of mutual fund over stocks :
A mutual fund gives diversification :
If you have only 1,000 to 5,000 to invest, the money will not buy many shares of a single stock, and it will certainly not buy many different stocks. By putting your money in only two or three stocks, you are exposed to the possibility that one of them will plummet in price, wiping out much of your invested capital.
Instead, when you put your 1,000 or 5,000 in a mutual fund, your money buys into a portfolio that may comprise of 50 or 100 different stocks. If one or two stocks in the portfolio get hit hard, your losses will be much more limited because many of the other stocks will probably be going up at the same time.
A professional skilled manager chooses stocks for you :
Managers of stock mutual funds have instant access to information about every stock around the world at the push of a few computer keys. They work in companies where teams of research analysts who study corporate annual reports and these analysts visit company executives and factories to evaluate the firms’ prospects first hand. But individual investors have limited access to such information, like these fund managers.
The only disadvantage in investing in a mutual funds is that you depend on the fund’s manager to make the right decisions regarding the fund’s portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected.
Anyway. buying a mutual fund can substantially reduce our long-term market risk and result in a higher net return if they are used for longer term horizons and they take all the worries which are associated with managing stocks and provide proper diversification. In general that mutual funds are always better than individual stocks, since they involve lower risks, less money and but safe returns, as we have seen in HDFC Top 200 .