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3 reasons why ETFs are better than unit trusts and stocks

By Ethan Ho

3 reasons why ETFs are better than unit trusts and stocks

3 reasons why ETFs

When it comes to topic of investments, the common asset types often talked about are stocks, unit trusts (synonymous with mutual funds) and exchange-traded funds (ETFs). What are the key differences and similarities? Moreover, as a new investor, which one should you look at?

Stocks are equities that companies give in exchange for funding to be listed as a public share on an exchange. When stocks get listed, they are known as initial public offering (IPO). Thereafter, they are responsible for performing up to expectations to increase stock price in order to increase value to shareholders. Investors who own a company’s stock are essentially the company’s shareholders.

As people buy stocks for investment purposes, the returns consist of capital gains (increase in share price) and/or dividend (not fixed). For volatile stocks that have prices fluctuating rapidly, it is usually riskier due to the high risk-to-reward ratio, where a risk premium is needed for investors to be willing to take up the risks. Stocks are traded publicly via an exchange, like SGX.

To have good returns on stocks, investors have to do their own analysis to avoid the two main associated risks that are systematic and stock-specific risk. Investing in a stock essentially means investing in a company. Investors would need to know whether the company is financially sound, have good prospects and management. Stock-specific risk is especially crucial when their investing horizons spans for months or years. If investors were to invest in companies without making substantial justification for their investments, the risks of losing money is highly possible. Systematic risk is also known as market risk, which affects the entire market, industry or sector. Even with good diversification, systematic risk can arise due to many different economic, political or even social factors. An example would be the financial crises in 1997 and 2008, where global stock markets were affected.

Blind Fold

Unit trusts are a type of investment instrument that focuses on creating an optimal portfolio of different assets to outperform the market. It is known as a collective investment scheme, regulated by Monetary Authority of Singapore (MAS). The assets included in unit trusts can range from bonds, stocks, gold, and different commodities which can be local and foreign. Unit trusts are usually provided by fund houses like BlackRock, JP Morgan, Aberdeen etc. Each trust is managed by a fund manager. The fund manager manages the components of the unit trust and charges an administrative fee ranging on average 1.5%-2% per annum. Investing in unit trusts means that your money pooled with money from other investors and invested in a portfolio of assets, which is then allocated to investors as 'units'.

As unit trusts are managed by professional fund managers and diversified, risks can be assumed to be hedged and lower than investing in stocks. However, not all unit trusts are created the same and some can be more aggressive than others in terms of risk-to-reward ratio. For example, some trusts focus heavily on equities in emerging markets (EM) while other trusts focuses more on developed markets. In simpler terms, unit trust is the diversified packaging of different assets classes across different markets, managed by professionals to cater for the needs of different investors. Unit trusts can only be bought through advisors or intermediaries, and prices are delayed up to 2 days from the date of the transaction due to forward pricing.

Counting Money

However, one major risk for investors that are keen to invest in unit trusts is actually the financial advisor. For the purchasing, redemption or switching of funds, an investor will need to go through a financial advisor or intermediary. To distinguish the difference between the fund manager and financial advisor: the fund manager is the person in-charge of the fund, while the financial advisor is the person whom you approach to buy funds. Why is buying trusts through a financial advisor a risk? It is because they earn a sales charge (between 2-5%) for every unit trust that an investor buys. This is a huge risk because when commission is tied to a financial instrument, sales talk becomes more apparent than real talk. While not all financial advisors are focused on just sales talk, the process of earning commissions through every sale of unit trusts is real. Therefore, it is difficult for advisors to align their own interests’ with their clients’ interests. If investors are really keen on buying unit trusts through an advisor, it is recommended that they fully understand the fund prospectus, product highlights sheet and do their own due diligence before investing. For more details on unit trusts, you can visit this link http://www.moneysense.gov.sg/Understanding-Financial-Products/Investments/Types-of-Investments/Unit-Trusts.aspx. For more scenarios where investors have lost money with their financial advisors, check out this link: http://www.investingnote.com/posts/27993

Money

Exchange-traded Funds (ETFs) are passive funds that are tracks an index, a commodity, bonds, or a basket of assets. ETFs are traded and priced publicly like a stock on a stock exchange, unlike unit trusts which are only bought through advisors or an intermediary and prices are not listed on public exchanges. Common examples of ETFs in Singapore include the SPDR STI ETF and SPDR Gold shares ETF, which tracks the STI and prices of gold respectively. As indexes such as the STI are usually used as public benchmarks for assessing an investment’s returns, investing in a fund that mirrors the index is a conventional way of investing. To illustrate, an STI ETF tracks the performance of the STI, and provides investors with a similar return as the index, with less fees. In short, it mirrors the index (albeit some ETFs might not mirror directly). The only other way to mirror the index, is to buy each index component stocks, which a minimum requirement purchase is 100 shares per lot. Furthermore, there are no costs other than the expense ratio, which is less than 1% per annum on average.

Saving

In sum, ETFs possess higher liquidity, transparency, cost efficiency as compared to unit trusts. It also removes the risks associated of investing through an advisor or intermediary. At the same time, ETFs also offer more exposure to the market and diversification compared to stocks. It reduces the stock-specific risks associated with stocks. Moreover, some ETFs do issue dividends. As a new or lazy investor, ETFs might just be the better option.

 
Ethan Ho
Ethan Ho

Personal description: Ethan is a self-taught investor who started investing in the US stock market, and the marketing lead for InvestingNote. Prior to his role in InvestingNote, he was a personal banker dealing with unit trusts and bancassurance in the wealth management division of a bank. He has Capital Markets and Financial Advisory Services (CMFAS) certification. He is a strong advocate for financial and investment literacy as he believes everyone should be able to manage their personal finances well.

Company description: InvestingNote is the free social network platform designed specifically for crowdsource investment ideas, news and interaction for the holistic stock investing community. Besides having access to stock data, users can upload research reports, utilize technical charts and make stock price targets that will be visible to the entire community. Users can also gain reputation points when they have followers, likes and posts. It promotes financial literacy and helps people make more well-informed investment decisions.

Website: www.investingnote.com