Mutual funds and exchange-traded funds (ETF) are both investment vehicles involving indirect access to the stock market.

The main difference between the two is the way they can be accessed. ETFs are traded in the stock market just like a normal individual stock. This means it has its own ticker and can be bought or sold in the ASX.

Managed funds, on the other hand, can be accessed through a provider (i.e. banks) who offers investment products they’ll manage on your behalf.

Exchange-traded funds (ETF)

An ETF is made to follow a group of stocks which closely represents the index movement. ETFs offer instant diversification because each board lot you buy is a package containing index stocks. The stocks in the package are chosen based on how their strength can affect the overall movement of the market index.

ETFs are products that provide access to a group of index funds, allowing you to buy and sell them on a publicly-traded market. An important thing to remember about ETFs is that it’s not made to beat the market but simply track it.

Pros

Buying a single board lot of an ETF provides instant fund diversification. Diversity distributes the risk between numbers of stocks to help mitigate losses in case some of the stocks in the package fail to perform well.

Transparency is one of the strengths of ETFs. You can see what stocks are included in the ETF you’re buying.

Since ETFs are traded in the stock market, you can buy or sell board lots during the trading period without any restrictions. You can also see the movement of prices and the status of your investments in real-time, immediately after your trading execution. This increases your capability to quickly gauge the market as the action happens.

ETFs can be processed directly by online brokers, traditional stockbrokers, or financial advisers. There’s less paperwork involved before you can participate in the stock exchange.

One of the best things about ETFs is the lower charges you incur upon trading. Since you’re not paying anyone to do the job for you, all you need to worry about are taxes and commissions your broker charges on each transaction.

Cons

Gains may not be as great compared to managed funds and direct stock investing. ETFs focus on large-cap stocks which have limited growth in exchange for stability and credibility. Exposure to smaller industries and their potential exponential growth are outside the reach of ETF investors.

Although ETFs have lower charges due to the elimination of a fund manager as the middleman, savings can be dwarfed by brokerage costs which are charged on every buy/sell transaction. This can be a bane for intraday and short-term traders.

ETF brokers usually charge a fixed fee for trades amounting to less than $10,000. For example, a broker charges a fixed rate of 3% for every transaction less than $10,000. Your trade amounted to $9,000 so you have to pay a fee amounting to $270 which is quite hefty. Although the rate decreases for bigger investments, rates will still hold at least around 0.3% for trades exceeding $10,000.

Managed funds

Allowing an expert fund manager to handle your funds for you is the best option if you don’t have time to look at stocks. Banks and other financial institutions usually offer this product to interested investors.

The goal of managed funds is to outperform the market through actively managing the funds. Depending on the level of your risk tolerance, it’s possible to gain greater returns compared to other investment vehicles.

Pros

You don’t need to research on the industries of the stocks you want to invest in because you’re paying a fund manager to do everything for you. This saves you from the stress of analyzing which stocks to invest in and the time when to enter/exit the market.

There are several portfolio choices you can choose from, each with varying degrees of risk and reward levels. You can select a portfolio based on the performance level you’re comfortable with and not on the stocks included in it; let fund managers worry which stocks will provide the promised returns.

Higher returns are possible in managed funds depending on market conditions. This investment scheme is better suited for investors who are ready to face higher risks in hopes of getting higher rewards.

Cons

Managed funds usually have higher opening capital compared to ETFs and other investment schemes. Aside from that, institutions offering managed funds need application forms to be filled out and requirements to be submitted before they let you avail their products. This can be inconvenient and time consuming for many people.

In managed funds, diversification is based on the fund manager’s analysis and decision. You can’t decide where you want to put your money. They can put it in a single stock or divide your funds into smaller amounts to allocate them in multiple stocks.

Managed funds provide limited information on what stocks your money is invested in. Some may find this uncomfortable, not knowing how their fund managers are using their hard-earned investments.

Managed funds have varying liquidity depending on the chosen strategy for growing funds. In extreme conditions, investors may be held from withdrawing their positions.

This scheme is not suited for intraday traders who want to actively look at the stock prices from time to time. Fund managers need to calculate the Net Asset Value (NAV) price of the portfolio at the end of the trading day before it can be shown to investors. They usually send the status of your portfolio on a daily basis or on a weekly or monthly basis, depending on your arrangement.

Managed funds charge higher fees because you’re basically paying another person to handle your money for you. Charges include payment for fund managers, tax reporting, management tools, access to service centers, and market bulletins sent to your email.

Which one to choose

Both are equally good to include in your portfolio. In choosing between managed funds and ETFs, these four factors should be taken into consideration:

Your investment plan

Never dive into investing without any strategy. Know which tools can help implement your plans. You should know your risk tolerance and the length you want to stay in the market.

If you plan to invest in European equities, choose an ETF that provides this option. Managed funds usually offer local stocks but they may also have ways to invest in international markets. Check both vehicles and choose which one suits your preference.

Accessibility and liquidity

Managed funds need a minimum funding to open an account and it’s usually much higher than the requirements for starting an ETF. However, it’s easier to deposit and add to your investments in a managed fund. You can process your deposits thru direct bank debits or accredited money transfer services.

ETFs require only the amount of each board lot to proceed with the transaction. They won’t require you to deposit $5,000 if you only need to buy worth $1,000 of stocks.

ETF providers usually partner with large investors called “market makers”. These institutional investors can meet investor demands by buying and selling units to maintain the liquidity of the ETFs.

Managed funds also employ a similar system which means both investment vehicles are flexible enough to meet the supply and demand of units for investors to play with.

Flexibility

ETFs are easily accessible in a way that they can be traded just like a normal stock. You can see right away the results of your trades without restrictions. Managed funds, on the other hand, may offer limited visibility on your investments since they only provide a report at the end of the trading day.

Taxes and costs

There are transactional costs and ongoing costs which investors need to consider in choosing which investment vehicle to pursue.

Managed funds incur both ongoing and transaction costs to pay for the fund manager’s service, taxes, and possible service charges. This can decrease the returns especially if you plan to hold the investment for a long period of time.

ETFs suffer from transactional costs since they can be traded like normal stocks. Taxes, commissions, and service charges are applied on every transaction. Short-term traders may find this detrimental to their investment’s performance, that’s why it’s best to go with a buy-and-hold strategy for ETFs.

Conclusion

Choosing between ETFs and managed funds depends on the structure you’re comfortable with. Each has their own merits and disadvantages and you should also consider the costs, flexibility, and accessibility of each option.

It’s important to determine your investment plans and objectives before you apply for any of the mentioned ventures.