Stock-picking vs funds: Why professional management can be better for retail investors

Investing, in principle, is about one thing: putting your money to work efficiently so that it compounds into greater wealth over time. As an investor, you can adopt two broad strategies: one is to select and manage individual stocks independently, the other is to delegate the job to professional fund managers through vehicles like mutual funds.

The attraction of managing your own portfolio is obvious. You save the management fee and retain complete control over your investments. However, this calculation does not account for the fact that professional investment management is not merely about picking stocks. It involves research, portfolio construction, risk management, execution and, importantly, behavioural discipline.

For most retail investors, attempting to replicate all of this alongside a full-time career may not be the most efficient use of their time or money. Professionally managed mutual funds offer them a more efficient way to build long-term wealth than investing in individual stocks themselves.

Expertise not easily available

The internet and artificial intelligence (AI) have made financial information more accessible than ever. You can download an annual report, read analyst opinions and use AI tools to compare companies in minutes.

However, access to information is not the same as acting upon it to your benefit. Professional fund managers typically have teams of analysts tracking different sectors, competitors, business cycles, regulation, accounting practices and management quality. They may meet company management, conduct channel checks with suppliers and distributors, and visit manufacturing facilities to understand whether the reality on the ground matches the numbers being reported.

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This breadth matters because a business may be performing well, but a new competitor can fundamentally alter its economics. Reliance Jio’s entry into India’s telecom industry, for instance, dramatically changed the competitive landscape for established players. That confidence is hard to develop when an investment decision is based primarily on share price or someone’s tip.

Biggest risk can be your behaviour

The second challenge is psychological.

You are naturally emotional about your money. When a stock falls sharply, it is difficult to look at the decline objectively. Consider Bajaj Finance during the Covid-19 market crash. The stock fell from around Rs.4,923 in February 2020 to about Rs.1,783 by May, a decline of roughly 64% from its peak.

Professional investors take advantage of such opportunities by buying at lower prices to make gains, but the non-professional ones lose due to panic. You do not write down why you are buying a stock or the circumstances that would make you change your mind.

So, when a stock price falls, the instinct is often to avoid admitting you made a mistake. The opposite happens when a stock rises sharply. You may be reluctant to sell because you fear missing out on further gains, even when the valuation has become excessive. Effectively, you end up holding losing investments for too long and holding winning investments for the wrong reasons.

Professional fund management puts a process between emotions and decisions. Investment committees, research frameworks, portfolio limits and regular reviews can reduce the likelihood that one person’s fear or excitement determines the portfolio.

Good decisions need to be acted upon

The third is execution. Even if you are good at research and manage emotions well, you may lack time. You have a profession and/or family to manage. Investing is usually a side activity.

This matters because markets can create opportunities or erode values quickly. A business can decline 30%, 40% or even 50%. Such falls can either become opportunities or permanent losses depending on how you respond.

A professional investment team acts on these developments timely manner to their advantage. You, on the other hand, may be involved in your professional or personal life, and simply unaware of what has changed and why.

There is also a significant difference between investing a few thousand rupees and managing a portfolio worth several lakhs or crores. As the amount of money grows, investment mistakes become increasingly consequential. The ability to buy a stock is not the same as the ability to manage a large portfolio of stocks successfully through different market cycles.

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Cost of an ever-changing portfolio

Even if you do everything right, tax may still drag you down. The composition of a successful long-term portfolio cannot remain fixed forever. Businesses decline, new companies emerge, and competitive advantages disappear.

Even the index changes its constituents over time. Therefore, if you manage individual stocks, you buy and sell stocks. When a sale generates a taxable capital gain, there is an immediate tax cost.

Mutual funds have an important structural advantage here. The fund house enjoys an income-tax exemption under Section 10(23D) of the Income Tax Act, 1961. The fund manager can sell one stock and purchase another within the mutual fund without the investor having to pay capital gains tax merely because the portfolio was changed.

As an investor in the mutual fund, you are taxed separately only when you withdraw your mutual fund investment. This effectively allows portfolio changes to take place within the mutual fund tax-free every time the fund manager buys or sells a stock.

Over long periods, the tax advantage of mutual funds alone pays more than the fee.

A rational trade-off

Some investors have the knowledge, temperament, time, and discipline to research businesses deeply and manage their portfolios successfully. For them, direct investing can make sense.

Though, they are a few exceptions from the era when there was information asymmetry and no taxes. Now, it is an uphill task.

Investing is about building wealth, not proving that you can pick stock. Therefore, for the majority of you, professional management is a rational trade-off.

The author is Founder, Zenith Finserve.