For any beginner investor, investing in either Mutual Funds or Exchange Traded Funds (ETFs) represent two possible starting points that a person can take. This is because both these investment instruments allow investors to take a hands-off approach after making their initial investment. In addition, these products pool money together to achieve broad base diversification to protect investors’ exposure to any one sector or company.
Many studies have shown that investing in the stock market over the long run will give you positive returns (passive investing), while actively managing your portfolio often lead to market returns which are equal or even below market returns (active investing).
What are Mutual Funds and ETFs?
ETFs are usually index-linked funds that bundle indices such as the Singapore’s Straits Times Index (STI), the benchmark for the largest 30 companies on our exchange. It could also be pegged to other countries’ indices, such as America’s S&P 500 or London’s FTSE 100.
These funds are usually not actively managed, and just simply track the index. Hence, they do not charge high, or in some cases, any management fees.
Investment managers usually actively manage mutual funds. What this means is that some fund managers constantly execute trades to buy and sell stocks in their care. These people who are actively working on your funds have to be paid, and logically, a higher management fee would be charged for these products.
One matter we like to stress is that even though you may not directly be actively managing your investment when you put your money in a Mutual Fund, the fact that you are engaging someone to actively manage it for you means that you’re an active investor. Many people don’t realize that, thinking that giving a sum of money to a fund manager equates to automatically making them a passive investor.
How to decide between investing in Mutual Funds or ETF?
1. Getting invested and trading
To purchase an ETF, all an investor needs to do in Singapore is open a brokerage account and buy the STI ETF. Doing this would require you to pay a brokerage fee to brokerage house that you are using. Over the course of your investment, you can choose to buy additional ETF stocks or sell your current holdings. This is done at the market price and trades can be executed throughout a working day, just like any other normal stock.
Buying a Mutual Fund differ slightly. Often, you can purchase the Mutual Fund through a bank or directly from the fund itself. You will often incur a transaction or commission fee. Investors can also buy or sell stocks of the Mutual Fund at their discretion.
Since many studies have supported the fact that having a professional fund manager does not guarantee your investment outperform the market, it makes sense to go with ETFs.
Mutual Funds charge a management fee that is paid to the people who manage your money. These fees usually range from 1% to 2.5%. Thus, investors have to consider whether these professionals can not only beat the market, but also beat it regularly by more than the fee they charge annually.
In addition, Mutual Funds have other operating costs like legal fees, accounting and auditing fees and marketing fees. This is taken out of the funds, and will decrease investors’ returns. In contrast, ETFs incur no such fees.
For retail investors, especially those with little experience in investing, ETFs provide an extremely transparent and liquid method to invest. ETFs are extremely liquid investments as their prices merely track that of the components of the index they are tracking.
Mutual Funds are also liquid. However, investors need to take note of any sales charges that they may incur when selling units in the fund. It is important to find out what these sales charges are, because these charges would ultimately affect your returns.
More choices, more responsibility
Having more investing choices often lead to competition, which in turn leads to better outcomes for retail investors. However, it is also the responsibility of individual investors to safeguard their own money by understanding exactly what they are investing into and understanding how the differences between these products could impact their returns.