Literature Review: Comparison Study Between Equity and Mutual Funds
Investors globally seek avenues to grow their wealth by allocating resources into different
financial instruments. Among
the most prominent investment options are equities and mutual funds. While both
investment types cater to individuals with
varying risk appetites and financial goals, their characteristics, risks, and returns have been
subject to extensive research.
This review synthesizes existing literature on the comparison between equity and mutual
funds.
1. Equities: High-Risk, High-Return Investments
Equities, or stocks, represent ownership in a company, and their returns are tied to the
performance of that company.
According to studies by Markowitz (1952), equities tend to offer higher returns over the
long term compared to other
investment avenues. This is because stock prices often reflect both company performance
and market sentiment. Research
by Dimson, Marsh, and Staunton (2002) found that equities have historically outperformed
other assets such as bonds and
gold in terms of returns.
However, equities are volatile. The volatility is influenced by macroeconomic factors such as
interest rates, inflation,
and geopolitical events (Fama & French, 1992). Direct investment in equities requires
significant market knowledge and a
tolerance for risk, making it suitable for experienced investors.
2. Mutual Funds: Diversified Investment Vehicles
Mutual funds pool resources from multiple investors to invest in a diversified portfolio of
stocks, bonds, or other
securities. Diversification, as emphasized in studies by Elton and Gruber (1995), reduces
unsystematic risk, making
mutual funds an appealing option for risk-averse investors. The professional management
of mutual funds by fund managers
ensures that investment decisions are based on thorough research and market analysis.
Empirical evidence suggests that mutual funds provide moderate returns with lower risk
compared to equities. For example,
Sharpe (1966) introduced the concept of the Sharpe ratio to measure risk-adjusted returns,
finding that mutual funds often
provide balanced risk-return profiles. However, mutual funds come with associated costs,
such as management fees and expense
ratios, which can erode returns over time.
3. Comparison of Risk and Returns
Numerous studies have compared the performance of equities and mutual funds. A study by
Ippolito (1992) found that while
equities have the potential for higher returns, mutual funds outperform equities during
periods of market downturns due to
their diversified nature. Additionally, investors in equities face higher risks as their
portfolios are often concentrated
in fewer stocks.
Mutual funds, especially index funds, have shown consistent returns that mirror market
indices, as highlighted by Bogle
(1999). In contrast, individual equity investments are subject to higher volatility and
require greater effort in monitoring
and analysis. Thus, the choice between the two depends on the investor's risk tolerance,
investment horizon, and financial
expertise.
4. Behavioral and Psychological Factors
Behavioral economics plays a crucial role in investment decisions. Barber and Odean (2000)
noted that individual equity
investors often exhibit overconfidence, leading to excessive trading and suboptimal returns.
On the other hand, mutual fund
investors benefit from professional management, which reduces emotional biases in
decision-making.
5. Market Trends and Innovations
Recent advancements in technology have transformed the investment landscape, with
online platforms and robo-advisors
making both equities and mutual funds more accessible. According to Statman (2020), this
democratization of financial tools
has blurred the lines between active and passive investment strategies, influencing the
comparative appeal of equities and
mutual funds.
Conclusion
The choice between equities and mutual funds hinges on individual investment goals, risk
appetite, and market knowledge.
While equities offer higher returns for those willing to accept greater risk, mutual funds
provide a safer, diversified
option for risk-averse investors. The literature suggests that both have unique advantages
and drawbacks, making them
complementary components of a well-rounded investment portfolio. Further research
should explore how technological
advancements and emerging market dynamics impact the performance and perception of
these investment vehicles.
