Glamorous and tempting: But is direct stock investing suitable for everyone?

Unsurprisingly, many individuals have taken notice and moved into direct stock investing. One look at the number of demat accounts being opened shows a clear trend.

A friend recently shared that since he can now comfortably generate better returns with his direct stocks (than mutual funds), he has moved all his portfolio to direct stocks. He started investing in MFs almost a decade ago, but his direct stocks adventure started just two or three years back.

So, it’s obvious that his recency bias has made him do what he did like many others who are taking up direct stocks in a big and serious manner nowadays.

That said, is it a sensible idea to just invest directly in stocks and not in mutual funds?

People have strong views about this based on their individual experiences. And to be fair, there is no one-size-fits-all answer.

Investing directly in stocks gives more control to build a focused portfolio that can attempt to generate higher returns and/or beat markets (and MFs). However, with some experience, one understands it is easier said than done.

The potential for higher returns exists in direct stocks, but so are the risks. And the reason is that if just a few of your stock picks in a concentrated portfolio start doing badly, your overall portfolio could take a serious hit. Experienced investors who have seen a few market cycles know this already. But those who have joined our markets in the last few years and have only seen it rise, might not understand this and how to deal with a falling or bear market.

For a majority of the investor population, mutual funds should form the core of their equity allocation. A well-managed portfolio with a good mix of active and passive mutual funds provides sufficiently good return outcomes with high probability. This wouldn’t sound right when our rising markets have made it look easy to make money from direct stocks.

Most people don’t have the time or the skill to properly analyse businesses behind the stocks. Also, picking a good stock or two is one thing. But building a well-diversified portfolio of several stocks with proper allocation and then consistently generating returns over the years (like what mutual funds do) is a different ball game altogether.

If you are a seasoned direct stock investor who has a solid experiences of years, you can ignore the rest of this article. But if you aren’t, and are increasingly being tempted to go into direct stocks heavily at the cost of (ignoring) mutual funds, then please read this.

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Equity allocation

Continue to keep your core equity allocation via equity mutual funds or ETFs only. How much? At least 80%. If you are new to markets, picking good mutual funds isn’t rocket science and you can go for a few schemes from different fund categories that will help you diversify sufficiently across different market cap segments like largecap, midcaps and smallcaps.

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Once the core equity MF portfolio is established, and you still want to invest in direct stocks, you can start with a small allocation. How you pick your stocks is important. Please don’t invest blindly based on tips you get from friends or social media. That will eventually stop working.

How much you invest in direct stocks would depend on your real investing experience, your interest (and ability to give time) in researching individual businesses and sectors, etc. After a few years, it will automatically be clear whether your direct stocks are doing well or your MFs. This period of assessment ideally should include a stint in poor or falling markets as well. That is because that is wherevery real investors get tested.

For those curious, the author is a small investor who invests in mutual funds as well as stocks. Fascinated with equities, over time, the author has invested in direct stocks and benefited from it but likes to diversify within equity asset and hence invested directly as well as via well-managed proven mutual funds.

Dev Ashish is RIA and founder of StableInvestor.