Shares vs. Equity Funds

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I would like to invest in the stock Market. What is the difference (or similarity) between investing in stocks or investing in an Equity Fund?

This is an excellent question sent to me by one of the followers of this column. I am sure many of us have wondered what the difference actually is.  Maybe you have heard of these Equity Funds and would like to know what they are all about.  I will actually start with what the similarity is.  In both cases you are investing in the Stock Market. You will only consider either of these options if you have already made a decision to invest in shares, also known as equities. This means you have evaluated the risks and rewards of the stock market and with that knowledge, have made a decision to invest. The stock market (or Nairobi Securities Exchange as we call it) gives you a platform to become an owner in a variety of businesses. What reflects your ownership in these companies is the number of shares you have. You can invest in the banking industry, telecommunications industry, insurance industry, manufacturing industry etc. In addition it also gives you an avenue to sell your shares in those businesses when you want.  If you invested in a private company or business and you wanted to sell your ownership in those companies, you would probably have to source the person buying your shares from you privately.  However there is a large pool of investors in the stock market who on a daily basis are buying and selling shares so you do not have to source the person buying the shares yourself.

When you invest directly, you have made a decision to buy into specific companies that are listed on the exchange.  You will either use professional advice or have done your own evaluation as to why you would like to invest in these companies. Remember at the end of the day it is a business so you have to understand what will make that specific business work, continue making profits etc. Depending on the amount of money you are investing, you will be allocated a certain number of shares in your personal name.  To invest you have to open a share trading account known as a CDS account (Central Depository System Account). Shares are electronically credited to this account when you buy and debited when you sell. You absorb the risk of the investments you have made personally i.e. if you buy a shares for ten shillings and you sell when it drops to five shillings, you have made a personal loss of five shillings.  On the other hand you gain from appreciation in price.  When you buy at ten shillings and you sell at fifteen shillings, you have made a personal profit of five shillings. Your gains or losses are limited to the companies you chose to invest in.  The most important thing to remember with directly investing in the stock market is that you are the decision maker. You decide what and when to buy and sell. The number of companies you are investing in is of course your decision and may be limited by the funds at your disposal.

You can look at an Equity fund like a sophisticated Chama. It uses the same principle of pooling resources like investment groups do.  An Equity fund is managed by professional investment managers who oversee the day- to- day decision making. It has pooled (or collected) funds from various investors and then those funds are invested in the Stock Market. Contrary to popular belief, the equity fund itself is not the investment.  It is simply a vehicle that investors can choose to use to invest in the stock market. The fund manager with that pool of funds will make the decision on what shares to buy or sell and when to do this.  You cannot invest through an Equity fund and then proceed to dictate what shares you want with your money.  The fund manager does not make decisions based on the Shs 100, 000 you have invested. He makes decisions based on the one hundred million shillings he may be managing. If you are particular about the shares you want to buy, just do it directly. However because this Equity Fund is invested in variety of shares, with your Shs 100, 000 you will get access to returns as well as risks from more shares than you would if you invested that money directly.  The most important thing to remember with an Equity fund is that you have delegated the decision making to somebody else.  You do not watch the individual shares on the stock market to ascertain whether you are making a profit or loss. You will not be credited with the shares on the stock market but rather shares in the Equity Fund known as units.  You will be monitoring the value of your units in that fund.  You will not open a CDS Account but just a unit account with the respective fund manager. Your job is to select the fund manager, understand their approach to investing and decide to trust them with your money.

As I said earlier, as an investor you have still made a decision to invest in the stock market. Obviously with direct investment you have made a decision to challenge yourself and learn about the specific companies with the aim of selecting those that you think will do well.  With the Equity funds you are not that involved with the decision-making but you get access to a wider pool and professional management.  The decision is ultimately yours. Remember either way investing in the stock market is not for money you need in the short term.  You must be prepared to ride out the volatility that is characteristic of the stock market. It is not where you put next terms school fees.

Waceke runs a program on personal financial management. Find her at waceke@centonomy.com|

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