The Difference Between ETFs And Managed Funds
When it comes to investing and building your portfolio, we normally think of purchasing individual shares. This is one of the many ways in which we can invest but lacks the diversification. This is where Managed Funds and Exchange Traded Funds (ETFs) can provide that benefit and many more.
Passive vs Active Investing
Firstly it's important to understand the difference between active and passive investing. Active investing is more of a hands-on method where your investments are generally managed by you or a portfolio/fund manager. Whereas passive investing involves less buying and selling as it is usually designed to attain the same returns as a market index or benchmark as closely as possible.
As an active investor you are trying to buy and sell stocks in an attempt to outperform a specific index such as the S&P 500. So when it comes to an active managed fund, an individual portfolio manager, or team of managers are all trying to make investment decisions for the fund to outperform the index. The success of the fund is then highly dependent on their in-depth research, forecasting and experience with the market.
Both ETFs and Managed funds can be passive or active depending on the investment strategy that you want to take.
How are ETFs different from Managed funds?
Simply put, think of ETFs and Managed funds as a group of assets. So you're not investing in just a single share/stock but are able to invest in a more diversified portfolio as they consist of multiple assets. In general, they differ in the way that it is being traded and priced.
An ETF can be purchased or sold on a stock exchange just like buying and selling a regular stock. Hence when it comes to buying and selling ETFs, you will incur a brokerage fee for executing your transactions on top of your annual fee. But the benefits of it being available on the stock exchange is that:
- You can sell your ETF at any time when the market is trading
- You can see live prices throughout the trading day so that you can actively manage it
- It is transparent as all the information about an ETF's underlying holdings is readily available on the investment manager's website
Where managed funds differ in trading is that instead of directly buying off the stock exchange, you have to purchase "units" of the fund from the fund manager, or through intermediaries such as financial advisers and platforms like Vanguard. This makes it less accessible and you have to pay an annual fee to the fund manager. But one of the great benefits of investing in a managed fund is that you do not have any brokerage fees, so it's perfect if you want to keep investing small amounts regularly or wanting to Dollar Cost Average.
What is Dollar Cost Averaging (DCA)?
Dollar-cost averaging (DCA) is an investment strategy in which you divide up the total amount to be invested across a period of time for a specific asset. So you basically purchase the asset regardless of the asset's price and consistently on regular intervals. The goal of DCA is to reduce the overall impact of volatility on the overall purchase as the price will likely vary each time you make a purchase.
The concept of DCA is so that you don't have to try to time the market and make the mistake of investing a big lump sum of your money with a poorly timed decision. This works best when there isn't a brokerage fee or transaction fee for each time you need to purchase the asset as that will reduce the amount of profits gained from the investment strategy. So keep that in mind when you're deciding which asset you're selecting to dollar cost average in.
Regardless of which investment strategy you decide to take, it is important to always take into consideration your financial situation and selecting the right asset or product that suits you. But the general advice is to start now as I mentioned in my previous posts about the power of compound interest which is definitely something that you don't want to miss out on.
QOTB
"Successful investing is about managing risk, not avoiding it"
By Benjamin Graham