What are the advantages and disadvantages of direct stocks versus managed funds?
Studies show that 92% of managed funds underperform the market, due to their size and high fees.
” Size is the enemy of performance.” Warren Buffett
With a directly owned stock portfolio you know exactly what you own and your dividend income.
Managed funds lack transparency. You don’t know what underlying stocks you own, or the income you can expect to receive.
Transparency is particularly important because, while market price fluctuations are inevitable, the dividend income paid by stocks generally stays stable and increases over time. You can live comfortably with price fluctuations if you know your dividend income is not affected. But this is not possible with managed funds.
Income transparency is also important for personal budgeting.
Dividend Imputation provides Australian stocks with a massive tax advantage, whereby the ATO refunds to Australian resident taxpayers on dividends they receive, the 30% tax companies pay on their profits. This represents a 30% uplift in income, and is a huge deal.
Australia is unique in avoiding what is known as the double taxation of company profits. In other countries, companies pay tax on their profits, but then shareholders pay tax again when the remaining profits are distributed as dividends.
Managed funds investing in overseas markets do not receive dividend imputation tax refunds.
Managed funds have other major tax disadvantages. New investors inherit the fund’s unrealised capital gains on the stocks it owns, and will be required to pay tax on these gains when the stocks are sold. New investors dilute unrealised capital losses, which disadvantages existing unitholders. Capital losses cannot be distributed to unit holders to offset against personal capital gains outside the fund.
The online brokerage cost of direct stock purchases is a miniscule 0.11% ( $110 on a $100,000 order).
Managed funds incur numerous fees, many opaque, which can include entry-exit fees, management fees, performance fees, buy-sell spreads, transaction costs, administration fees, trustee fees, custodian fees, platform fees, and fund-of-fund fees. Annual fees and costs can amount to 2% or more.
Investors need to be aware that they are paying these underlying managed product fees, in addition to any investment advisory and wealth management fees they are paying.
Direct stock ownership gives you the ultimate security of the stock title registered directly in your name.
With managed funds you own units in the fund, but not the actual underlying investments. Incidences of fund manager fraud have cost investors dearly in the past.
See also Investment advice, fees & bias