Managed Funds vs ETFs: Which is Better for Your Portfolio?
When it comes to investing, Australians have a wealth of options. Two of the most popular choices are managed funds and Exchange Traded Funds (ETFs). Both offer a way to diversify your investments, but they operate differently and come with their own set of advantages and disadvantages. Understanding these differences is crucial for making informed decisions about your portfolio.
This article provides a comprehensive comparison of managed funds and ETFs, focusing on key factors such as fees, diversification, investment strategy, liquidity, and transparency. By the end, you should have a clearer understanding of which option aligns best with your individual investment needs and goals.
Fees and Expenses
One of the most significant factors to consider when choosing between managed funds and ETFs is the cost. Fees can eat into your returns over time, so it's essential to understand the different types of fees associated with each investment vehicle.
Managed Funds
Managed funds typically charge higher fees than ETFs. These fees cover the costs of professional fund management, research, and administration. Common types of fees associated with managed funds include:
Management Expense Ratio (MER): This is an annual fee that covers the fund manager's costs. MERs can range from around 0.5% to over 2.5% per year, depending on the fund's investment strategy and the manager's expertise.
Performance Fees: Some managed funds charge performance fees if they outperform a specific benchmark. These fees can be substantial, sometimes as high as 20% of the outperformance.
Entry and Exit Fees: Some funds may charge fees when you invest in or withdraw from the fund. These fees are becoming less common but are still worth checking for.
ETFs
ETFs generally have lower fees than managed funds. Because many ETFs track a specific index, they require less active management, resulting in lower operating costs. Common fees associated with ETFs include:
Management Expense Ratio (MER): Similar to managed funds, ETFs also charge an MER. However, ETF MERs are typically much lower, often ranging from 0.05% to 0.5% per year.
Brokerage Fees: ETFs are bought and sold on stock exchanges, so you'll need to pay brokerage fees each time you trade them. These fees can vary depending on your broker.
Bid-Ask Spread: The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). This spread represents a transaction cost.
Comparison: ETFs generally offer a significant cost advantage over managed funds, especially for investors who are cost-conscious and prefer a passive investment approach. However, it's important to consider that the lower fees of ETFs may come with less active management and potentially lower returns in some market conditions.
Diversification
Diversification is a key principle of investing, as it helps to reduce risk by spreading your investments across a range of assets. Both managed funds and ETFs offer diversification, but they do so in different ways.
Managed Funds
Managed funds typically invest in a wide range of assets, such as stocks, bonds, and property. The fund manager actively selects the assets to include in the portfolio, aiming to achieve a specific investment objective. The level of diversification within a managed fund can vary depending on the fund's mandate. Some funds may focus on a specific sector or industry, while others may have a broader investment scope.
ETFs
ETFs also offer diversification by tracking a specific index or market segment. For example, an ETF might track the S&P/ASX 200, which includes the 200 largest companies listed on the Australian Securities Exchange. By investing in such an ETF, you gain exposure to a diversified portfolio of Australian equities. The diversification offered by an ETF is determined by the composition of the index it tracks.
Comparison
Both managed funds and ETFs can provide diversification, but the approach differs. Managed funds offer active diversification, where the fund manager makes decisions about which assets to include in the portfolio. ETFs offer passive diversification, where the portfolio is designed to mirror a specific index. The best option for you will depend on your investment goals and risk tolerance. If you prefer a more hands-on approach with the potential for higher returns, a managed fund may be suitable. If you prefer a low-cost, diversified investment that tracks a specific market, an ETF may be a better choice.
Investment Strategy
The investment strategy employed by a fund is a crucial factor to consider. Managed funds and ETFs differ significantly in their approach to investment management.
Managed Funds
Managed funds are actively managed, meaning that a professional fund manager makes decisions about which assets to buy and sell, with the goal of outperforming a specific benchmark or achieving a particular investment objective. Active management involves research, analysis, and strategic decision-making. Fund managers may use various techniques, such as fundamental analysis, technical analysis, and macroeconomic forecasting, to inform their investment decisions. The success of a managed fund depends heavily on the skill and expertise of the fund manager.
ETFs
ETFs are typically passively managed, meaning that they aim to replicate the performance of a specific index or market segment. The fund manager does not actively select assets but instead buys and holds the securities included in the index. This passive approach results in lower fees and greater transparency. Because ETFs are designed to track an index, their performance will closely mirror the performance of that index. This can be beneficial for investors who want to gain exposure to a specific market or sector without the need for active management.
Comparison
The choice between active and passive management depends on your investment philosophy and risk tolerance. Active management offers the potential for higher returns, but it also comes with higher fees and the risk of underperforming the market. Passive management provides a low-cost, diversified investment that tracks a specific index. If you believe that a skilled fund manager can consistently outperform the market, a managed fund may be a good option. If you prefer a low-cost, hands-off approach, an ETF may be more suitable. You can learn more about Assetgrowth and our services to see how we can help you build your investment strategy.
Liquidity
Liquidity refers to how easily an investment can be bought or sold without affecting its price. Liquidity is an important consideration for investors, as it allows them to access their funds quickly if needed.
Managed Funds
Managed funds are typically less liquid than ETFs. When you want to buy or sell units in a managed fund, you usually need to transact directly with the fund manager. This process can take a few days, as the fund manager needs to calculate the unit price based on the fund's net asset value (NAV). Additionally, some managed funds may have restrictions on withdrawals, such as minimum holding periods or redemption fees.
ETFs
ETFs are highly liquid, as they are traded on stock exchanges like shares. You can buy or sell ETFs at any time during market hours through a broker. The price of an ETF is determined by supply and demand, and transactions are typically executed quickly. This high level of liquidity makes ETFs a convenient option for investors who may need to access their funds quickly.
Comparison
ETFs offer a significant liquidity advantage over managed funds. The ability to buy and sell ETFs quickly and easily on a stock exchange makes them a more flexible investment option, especially for investors who may need to access their funds on short notice. Managed funds, on the other hand, may be more suitable for long-term investors who are less concerned about immediate liquidity.
Transparency
Transparency refers to the availability of information about an investment, such as its holdings, performance, and fees. Transparency is important for investors, as it allows them to understand what they are investing in and how their investments are performing.
Managed Funds
Managed funds typically provide less transparency than ETFs. While managed funds are required to disclose their holdings and performance on a regular basis (e.g., quarterly or annually), the information may not be as readily available or as detailed as with ETFs. Additionally, the investment strategies employed by managed funds can be complex and difficult to understand.
ETFs
ETFs are generally more transparent than managed funds. Because ETFs track a specific index, their holdings are publicly available and updated frequently. This allows investors to see exactly which assets are included in the ETF's portfolio and how they are weighted. Additionally, ETFs are required to disclose their performance and fees on a regular basis. This high level of transparency makes it easier for investors to understand what they are investing in and how their investments are performing. You can find frequently asked questions on our website.
Comparison
ETFs offer a greater degree of transparency than managed funds. The readily available information about ETF holdings, performance, and fees makes them a more attractive option for investors who value transparency and want to have a clear understanding of their investments. Managed funds, on the other hand, may be more suitable for investors who are comfortable with less transparency and rely on the expertise of the fund manager.
Conclusion:
Choosing between managed funds and ETFs depends on your individual circumstances, investment goals, and risk tolerance. ETFs generally offer lower fees, greater liquidity, and higher transparency, making them a popular choice for cost-conscious investors who prefer a passive investment approach. Managed funds, on the other hand, offer the potential for higher returns through active management, but they come with higher fees and less transparency. Consider your own needs and preferences carefully before making a decision. When choosing a provider, consider what Assetgrowth offers and how it aligns with your needs.