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In today’s world, there’s many different methods and strategies for those looking to invest.
It can all become a bit overwhelming especially if it’s your first time and you don’t know where to start. It’s not uncommon to hear about shares, ETFs, or managed funds as ways to invest, but before choosing, it’s important to understand these financial instruments and how they work.
Shares
Shares or stocks (used interchangeably) represent an ownership stake in a company. However, in comparison to small business owners who own an entire business, the stake one takes in a publicly listed company such as Commonwealth Bank or Woolworths Group is fractional.
Publicly listed companies trade on ‘stock exchanges’, in Australia, the leading exchange is the ASX. Though, there are multiple exchanges around the globe listing shares in their respective countries. Most commonly, you may hear about the NASDAQ or New York Stock Exchange in the United States. These exchanges allow buyers and sellers to trade shares quickly and easily, and give rise to one of shares greatest attributes, liquidity. On the ASX, shares can be sold, and the proceeds of that sale are available typically in two days. Compare this to other assets classes such as property where assets can sit for months before a buyer is found.
This liquidity means that shares can experience large changes in price (volatility). This can lead to a capital gain (if the price has risen) however, there remains the possibility of the share price falling at which point, selling the holding would realise a capital loss. This gain (or potential loss) is only one aspect of the overall return potential. Many companies, especially mature businesses, pay dividends. A dividend is when a company distributes a portion of their profits to shareholders. Thes payments can make up a significant portion of the return in any given year. It’s important to note these payments are not guaranteed, and one must be comfortable weathering share price fluctuations along the way.
For those investing directly in shares, they can expect high volatility as share prices fluctuate daily. It also requires a lot of time and knowledge to research and monitor companies before taking a stake and then reviewing the company to ensure the business still represents a worthwhile investment.
Exchange Traded Funds (ETFs)
Given the time and effort required to successfully invest in shares, many time-poor investors turn to other investment vehicles, such as Exchange Traded Funds (ETFs). An ETF trades on the stock exchange and can be bought much like individual shares. The key difference is that this represents a group of assets (typically hundreds of different companies). Common examples are the top 300 listed companies in Australia, or the top 500 listed companies in the US. ETFs can also target niches such as healthcare (i.e., buying only healthcare related companies) or regions (i.e., buying companies only listed in Japan). Just as individual shares do, the price of the ETF fluctuates throughout the day, and they typically pay dividends too.
To elaborate, buying an ETF which tracks the ASX300 index (top 300 largest companies by market capitalisation on the ASX) gives you a fractional ownership of each company relative to their weighting in the index (i.e., 10% of your investment goes into shares in Commonwealth Bank (CBA) whilst only 1% is directed to Coles (COL) shares). ETFs can provide the highly sought after ‘diversification’ to investors who are looking to reduce risk by not putting all their eggs in one basket.
Unlike shares, ETFs will charge a small asset-based investment fee in conjunction with the brokerage charged to purchase and sell the holding. It’s important to be aware of what these fees may be, as investment fees and costs can erode returns over time.
Managed Funds
Alternatively, one could invest using managed funds. Much like an ETF, buying units in a managed fund will see your money pooled with hundreds or thousands of other investors and assets are then bought and sold using this pool of money by fund managers. Like ETF’s there are a wide range of option, but these funds will often be aiming to invest in a particular market or asset class and be very selective of the shares/assets they buy, as opposed to an index-based fund that buys a bit of everything. For example, a managed fund investing in Australian equities might aim to outperform the top 300 companies by choosing to concentrate their investment in only 30-40 companies they believe are the best businesses. Managed funds are also a great way to access other asset classes such as fixed interest or property and infrastructure.
Unlike shares and ETFs, managed funds cannot be traded on stock exchanges, instead investors need to apply directly with the fund or purchase units through a dedicated investment platform. Another difference is that managed funds are only priced and traded once a day, rather than actively throughout the day like shares and ETFs. Finally, managed funds typically have minimums on one’s initial investment. These minimums fluctuate between funds, but is something to keep in mind when looking at funds to invest in. It is also important to note that investment fees for managed funds are typically higher than ETFs – especially for actively managed funds – however, there’s no brokerage when funds are traded.
Managed funds are most typically the preferred option of those investing larger lump sums, unconcerned by minimum investment limits, seeking diversification and the expert active management available from the wide pool of fund managers available.
So, which one should I use?
The answer to this question is different for everyone, but it’s important to note that you’re not restricted to any one investment vehicle. Diversification is key to good portfolio, and this can be achieved with a variety of financial instruments. Some portfolios even combine of all three.
The variety available can create confusion, as each portfolio has its own structure, costs, risks and potential benefits. The best choice out of these options will depend on your financial position, goals, risk profile, and more. As such, it’s important to consult a financial adviser to ensure you find the mix that best suits your goals and objectives.
FOR MORE INFORMATION
If you would like to learn more about the topics discussed in this article, please contact local RSM Financial Adviser.
The information provided on this website is general in nature and does not constitute financial advice. It has been prepared without taking into account your personal circumstances, objectives, financial situation, or needs. It is important that you seek financial advice before implementing any financial strategy.
Where a financial product is referred to, you should read the Product Disclosure Statement and Target Market Determination and seek financial advice. RSM Financial Services Australia Pty Ltd ABN 22 009 176 354 holds Australian Financial Services Licence No. 238282.
