We recently received a request from an Investing Compass listener to go through why I choose managed funds over ETFs.

It’s a great question.

Both have a lot in common, but there are some characteristics that differentiate them and might mean that one works better for you than the other.

It comes down to a battle between a stalwart of the industry, lauded by financial advisers, and the new kid on the block that is improving accessibility for everyday investors.

Managed funds have been around for a long while. Some of Australia’s oldest managed funds were launched over 65 years ago. It has mainly been an adviser’s game. Perpetual manages one of Australia’s oldest managed funds. Their client base skews heavily towards advisers, with around 80% of their assets coming from advised clients.

ETFs are the (relatively) new kids on the block and have been in Australia for around 20 years. They offer an easy way to trade and have no paperwork if you’ve already have a brokerage account set up. ETFs are increasingly popular with investors and many fund managers are embracing them as a new way to bring in client funds. ETFs have never been more popular.

We’ve outlined the differences between the two investment products several times. You’re able to find the information below.

The following chart outlines the main differences.

Investment product comparison

My own experience with ETFs and Managed Funds

The request that we received from the Investing Compass listener specifically asked what I like about managed funds. We’ve called out that they are part of my portfolio a few times on the podcast.

I like managed funds for a few reasons. The first relates to my savings habits.

I invest from every paycheque into managed funds. I’m able to do that because the minimum additional investment amount is $1. If I have extra funds available at the end of the month, I will put it into my managed fund. In short, I make a lot of contributions.

A core part of my investment strategy is focusing on what is in my control. Reducing the brokerage that I pay will help me over the long term. Investing as much as I can will help me over the long term. Managed funds suit both purposes.

The alternative to my approach is to save from each paycheque until I amass an amount that justifies the cost of brokerage that I am going to pay to trade an ETF. This is dependent on your broker, and your savings levels. Stake is one of the lowest cost brokers on the market. They charge $3 per transaction. Commsec has the largest market share in Australia. If you are an investor in Australia, it is more likely that you’re paying their fee of $5 for trades up to $1,000, and $10 up to $3,000.

This can be a large percentage of the funds you are investing if you are investing frequently. I would have my money out of the market for longer than I would like to achieve a transaction cost that I’m comfortable paying time and time again.

Let’s illustrate the difference small contributions can make. You wouldn’t make these additional contributions unless there were no transaction costs.

In a simplified example, if I had $100,000 and invested $1,000 per month for 20 years, I would have $1,035,094 ($631,688 adjusted for inflation)*.

I get paid twice a month. If I invest $50 more per paycheque, my balance would be $1,091,994 ($666,412 adjusted for inflation)*.

This difference in my balance is without taking on any extra risk and without any extra cost to me.

Part of this decision is also behavioural. Having the cash sitting there, waiting to invest, opens up the opportunity for a couple of things to happen. The first is that I deviate from my investment strategy and speculate. I know this because I’ve done it before. Once I’ve reached a sizeable trade amount, it is easier for me to consider investing in investments that may not be part of my investment strategy.

My job makes this more likely. I read analyst reports all day telling me about undervalued companies. I read a lot of commentary about “can’t miss” opportunities. I am constantly exposed to eye-watering returns. It is easy for me to block out this noise and focus on what I am trying to achieve when I don’t have parcels of money sitting there ready to invest. I want to reduce behavioural risk. I invest it, and it is gone from my mind.

The other scenario is that I try to time the market. I’ve waited to save up to a large parcel of money. I worry more about the unit price I’m going to get.

For joint goals with my husband, we use an automatic investment feature. We don’t even think about this one. The managed fund automatically takes the money from our bank account and invests it into our chosen fund. Some brokers now offer this feature, but we have been investing in this managed fund for a long while.

A more general note here. Alongside the above rationale for why managed funds suit my situation, it’s also important to be efficient with your investments - but not to the detriment of your total return outcomes. The industry will always be innovating. There will always be new investment products and options for investors to choose from. Choosing a marginally better option each and every time that one appears will be to the detriment of your outcomes. You’ll incur tax on sale (if you’ve made a profit) and transaction costs. Investors know in principle not to chase returns and switch in and out of products. There should be a logical and sensible reason why you decide to switch out of an investment product with a long-term plan. You will inevitably continue to see innovation as more investment product providers compete for your money.

There are of course, downsides to managed funds compared to ETFs. These investment products are trying to find solutions that will suit the majority while still running a profitable business. There is no perfect investment vehicle.

Managed funds are not as easy to set up as ETFs. There’s paperwork involved, and often the processing lead times mean that you aren’t issued your units in the fund immediately. This doesn’t bother me. The paperwork is usually only at the beginning of the process and is quite seamless after.

Managed funds also tend to be marginally more expensive than ETFs. Compared to the savings from the brokerage I’m not paying, the difference in management fee is negligible. It’s important if you’re considering between the two investment products that you consider all fees when making a decision. I’ve written on the total cost of owning an ETF here.

A large concern that many investors have are the taxes that are associated with managed funds. The way that managed funds pool assets with other investors means that the actions of other investors impact you. When investors sell out of the fund, they leave you with the capital gains consequences. Many investors were burned by this during the GFC when investors panic-sold and the remaining members were left holding the bag. Many investors who were investing when this occurred will never touch managed funds because of these poor experiences.

Again – no investment is perfect. It would be nice if I didn’t face tax consequences from the actions of other investors. It would also be nice if I didn’t get charged every time I wanted to make a trade on an ETF. Ultimately, managed funds solve more problems for me than ETFs for the parts of my portfolio where I use them.

There is no ‘better’, just what’s right for you

You should never have to pick a ‘church’ you belong to. Investing is a means to an end, and investments are just the vehicles to get there. One approach may be right for some investors, and not a great fit for another. Even more commonly, both approaches may be right.

I’ve written about why I prefer managed funds, but I also invest in ETFs. They serve different purposes in my investment portfolio and are aligned to different goals. The managed fund industry is still innovating, which means that some investment options can’t be accessed unless you have a high minimum investment. With unlisted funds, the circumstances and benefits may change from provider to provider. There are some asset classes and investment options that are easier to access with ETFs.

It's important that investors do not fall into the habit of having to label yourself. You do not have to choose whether you are a managed fund or an ETF investor. You do not need to choose whether you are a growth or income investor to be a successful investor. You do not need to choose whether you are a property disciple or a share supporter. These investments are just tools for you to reach your goals – use them when necessary and pick from the whole toolbelt instead of just a subset.

*Based on Morningstar Investment Management’s long-term forecast returns for Australian equities at 8% p.a., and a 2.5% inflation rate.

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