Where to invest: direct stock or investment fund?

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If you have P10,000 right now that you’re ready to invest, where would you place it? Buy direct stocks or put it in UITF, mutual fund, PERA account, or exchange traded fund like the First Metro Philippine Equity Exchange Traded Fund?

In this article, I’m going to discuss the difference between buying stocks directly from the market or joining in one of the managed investment funds.

Personal stock investment

Making an investment decision is a very personal one.

It is also one of the most challenging to make simply because of the multitude of options that exist today. Anyone who’s new to personal finance planning and just starting to invest, it can be very overwhelming.

And one of the most-oft asked questions is where to put your hard-earned money. Trying to answer this question alone would net so many options, including passive income alternatives like securities, real estate, digital products, e-commerce, and business.

Say, that you have narrowed down your choices to investing in stocks. You would be left with two main selections: investing in managed funds or buying company shares directly from the stock market.

Investing in managed funds

I’d say if you’re really new to all of this, it’s best to start with managed funds.

Managed funds are companies that are regulated by the government and allowed to invite the public to invest in them. These funds are in turn invested in many assets such as stocks, bonds, and other types of securities.

Examples are the following.

Advantages of managed funds

There are many advantages of managed funds, but I’m going to mention just three of the most compelling reasons why you’re better off with them in comparison with owning stocks yourself.

Passive income

Perhaps the biggest advantage of these funds is that they really are pure form of passive income. You put up the capital, and these companies do everything for you. Whether you’d be invested in equities, bonds, or money market securities, in return, you get to enjoy potential earnings over time.

Passive income allows you to potentially earn while asleep. Because the funds are invested in a way that you don’t have to be directly involved, you get to enjoy possible growth of your net worth while living your best life.

Fund manager

These funds hire a manager, someone who’s an expert on securities, to do the trading on your and and the rest of the investors’ behalf. The fund manager is responsible in buying and selling stocks, bonds and other assets that could provide the best value to you.

What this means is that you don’t have to be an expert or a securities analysts. Unlike owning direct stocks, the everyday management and operation of the fund is taken care of by someone hired to do exactly just that.

That means anyone who’s old enough (at least 18 years old) and understand how these funds work can actually start investing. In short, they’re suited for people who does not have the time or the aptitude to study and make money out of the market.

Convenience

Lastly, based most of my experience in dealing with these funds, I really can’t say enough good things about convenience. This is true especially when you open an account with an institution that offers several of them at once, and makes them available to you through online banking.

For example, a long time ago, I was invested in a UITF with a bank. Due to their online platform, I can easily add to my investments, view the current value of my funds, and even close the account to redeem my money.

So dealing with your investments is not unlike managing your bank account with an online access. It’s as easy as that. It makes everything really simple and accessible.

Direct stocks

Buying direct stocks is one of the most exciting things you can do. I know. And it is also one of the riskiest in terms of investments.

Having the ability to purchase and own stocks means that you eliminate the middle man, i.e. the fund manager and investments funds. Instead, you go right to the Philippine Stock Exchange (for equities), BSP and companies (for bonds), or banks (for money market securities like long term negotiable certificate of deposit or LTNCD).

Advantages of owning direct stocks

Less fees

This is perhaps its greatest appeal. Having less fees on your investments actually can net you larger sums in the long run. By owning your own stocks, bonds and other securities, you get to minimize the fees that are associated with trading transactions.

For example, a typical mutual fund has a fee called sales load or front-end fee. It is expressed as a percentage of the amount that you put up, usually about 2%. Some even charge up to 3%.

On top of that, all funds have a management fee that is charged annually. The fee ranges between 0.25% to about 2.5% on some of the funds. While you won’t have to pay this out of pocket, the fee is computed into the value of your shares or unit of participation.

In contrast, buying your own stocks would charge 0.30% upfront. When you sell your shares to redeem your investment, there is 0.90% fee out of the gate. (This means that to get even, your portfolio must grow at least 1.2%)

But the ultimate advantage is that there is no management fee. That’s because you are your own portfolio manager.

To better understand, I measured the impact of fees between a fund that’s charging sales fee of 2% and management fee of 2.5% and stock with 0.30% upfront fee and 0.90% exit fee. In this comparison, we have the following assumptions:

  • Yearly investment of P12,000.
  • Both fund and stocks grow 10% annually.
  • Time horizon is 30 years.
YearFundsStocks
112,906.6013,160.40
227,071.5927,636.84
342,617.6743,560.92
459,679.5061,077.42
578,404.8580,345.56
10203,248.24209,742.88
15402,035.34418,138.57
20718,562.41753,761.90
251,222,565.841,294,286.64
302,025,086.352,145,323.87

As you can see, assuming everything is equal except for the fees, direct stocks is 5.6% higher than in the investment fund at the end of three decades.

Now, this comparison is very simplistic because the assumption is that your stocks would perform the same way as the funds. In reality, returns would vary.

Dividends

With the exception of FMETF, all funds would reinvest whatever dividends they receive back to its holdings.

Meaning, when the companies (BPI, BDO SM, etc) that are part of its portfolio issue dividends, the funds would choose to keep and use them to buy more shares of these companies. The result is that the overall value of the funds increase.

In contrast, when you have your own shares of companies, these dividends are issued directly to you.

The consequence however is that you will be taxed up to 10%. And if you choose not to reinvest your dividends, the value of your portfolio remains the same.

Choice of securities

When you invest in funds, the fund manager chooses the company shares, the number of shares, and the timing of the trade. The effect is that you won’t be able to invest in companies that you might like but are not part of your funds’ portfolio.

On the other hand, when you own stocks, you have the liberty to choose which shares you’d want to purchase. You may also choose to keep them for a length of time that you prefer or you can sell them any time you want.

Disadvantages of owning stocks

You have to be an expert, or at least try to be one

Now, the main disadvantage of having your own securities like equities is that you would have to study securities analysis.

People lose money in the market because they don’t know what they’re doing. And considering that you’re competing with other investors and companies that are out to get the most value for their capital, it can be very, very risky.

And it’s not just about acquiring your companies you like. You might also need to check at what price you’d be willing to buy or sell them to realize a profit. Additionally, you would need to think about the timing of your trades.

In short, managing your own portfolio is not as easy as it may appear.

Yes, you may be able to lessen fees, but it will also require that you are knowledgeable about the market, the fundamental value of companies, and technical analysis to optimize the prices of shares at which you’re trading.

Time

Another drawback is that you would need to carve out time from your busy schedule to monitor your portfolio. The value of equities change real-time, and if you’re not quick enough you might miss out important deals that either could make you a profit or save your portfolio from crashing.

The thing is that the stock market is open during office hours.

That could be a challenge when you have a full-time job. Not only that, you’d need some way to be always connected with the market like a trading platform, which would require that a stable internet connection and an appropriate device.

Risk management

Lastly, investing in equities could be very risky. It could even be more apparent when you’re doing the trading on your own, and there is no expert to guide you or do it on your behalf.

Risk management is about a series of steps that you take in order to minimize capital loss. It may start from the assets that make up your portfolio, the industry they belong, the kind of business they’re engaged with, and the economic climate.

And when you do lose, it could help you decide whether to stick it out or get out of the market and park your money elsewhere before situations improve.

Conclusion

In conclusion, I would think of the choice between investment funds and direct stock ownership as a question about fees and personal resources.

If you might have no time to learn about trading or manage your own portfolio, then be willing to pay some fees to let someone do it on your behalf.

On the other hand, if you’re willing to put in the hours learning about coming up with and maintaining a winning portfolio of stocks and securities of your own, and having the mental toughness to manage risks when things are not going your way, then being a direct shareholders may better suit you.