What are the differences between ETF’s and Managed Funds?
A lot of people that start investing just put there money into something their friends have said has been working really well for them. You probably have heard of particular stocks that have been doing well or maybe delved into some crypto…
Unfortunately, by doing this, you are taking a punt, without actually understanding the underlying fundamentals of the stock or crypto, you are essentially better off picking a horse at the Melbourne Cup because you like the look of it and its name is really cool.
Which is why I wanted to delve into this investing series in the first place, to give you, a beginner to intermediate investor, an understanding of how to use your money to grow your wealth and to not flush it down the drown on a few bets you took on a business or coin that your friend suggested.
What has that got to do with understanding what ETF’s and Managed funds are?
Well, quite a lot, because again, people are just putting money into these “safe-havens” without truly understanding what they are.
You should know where you are putting you money and understand exactly what is happening with it, that way you can sleep well at night knowing the your money is being used for good and also that you won’t lose half of it literally overnight.
Let’s delve into what I think an Exchange Traded Fund and Managed Fund is…
An ETF is a basket of stocks, commodities, real-estate and even crypto these days that can be exchanged on a local stock exchange, such as the ASX (Australian Stock Exchange).
Essentially, it can track an index, which is a method to track the performance of a group assets in a particular market, eg; the ASX 200 which tracks the performance of the top 200 companies within Australia. (1)
Whereas a Managed Fund (or Mutual Fund for the proper term) is where a large number of investors pool there money and entrust a particular fund/investor to invest on their behalf. (2)
Which means that you could gather 10 friends and all put $2,000 into a trust/account and entrust your investor friend to use your money and invest it into particular stocks, commodities, REIT’s etc. Expecting that your investor friend can beat the market average over time.
Now you know the difference between the two, which is the best investment vehicle for you?
And that comes back to the question of the last ten to twenty years…
Do you invest Passively or Actively?
ETF’s are generally quite passive in nature, as they will just follow the broader market, where as a Mutual Fund is generally quite active, as they have someone choosing which stocks, ETF’s or assets to invest in.
Passive investing normally has less costs involved and is more of a set and forget approach, although I never would suggest just forgetting about where you have invested your money. For most people, this method of investing will work and work quite well in fact.
As you are investing in the broader market, through an ETF, you will have diversified your portfolio significantly, reducing risk overall.
And you just put small chunks of money in over time to grow your passive portfolio, meaning you don’t have to spend huge amounts of time researching individual companies or the markets.
However, it does not mean there is no risk involved, as there is an overall market risk if that particular index falls by 20-50%.
Whereas Active investing is the opposite, with more fees to pay the fund manager to try and beat the overall market and earn higher returns. Studies completed suggest that picking the right person to entrust your money to is really important, as the majority of active fund managers do not beat the market average over the long run after fees are taken into consideration.
I myself am an active investor, where I have a portfolio of ETF’s, individual stocks and a little bit of crypto. Mainly because I believe based on much research that we will not see a lot of gains in the overall market over the next 10 years, however I still see value in owning companies that have proven to do well over time and will continue to do well in the next 10 years.
Of course, I may be wrong, but for now, you have to decide for yourself what you would rather do.
It is the ultimate Red pill, Blue pill question (if you are a matrix fan), but before you decide, I would suggest speaking to your certified Financial Planner before you start creating your portfolio outside of your super.
Until next time,
Take Back Control
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