Sharemarket Basics
Direct Investment
With direct investment in the share market, the investor personally manages his or her share portfolio and is responsible for all investment decisions, including:
- which companies to invest in and how to source up-to-date and impartial research;
- what level of exposure is acceptable to each industry/business sector;
- when to buy and sell, and in what quantities;
- appropriate capital management; and
- administrative record keeping for analysis and tax purposes.
Generally, a direct investor’s main costs will be brokerage payable to the share broker who executes share trades on the investor’s behalf. However, even that cost need not be substantial: there are many on-line discount brokers who will execute trades in real-time for flat fee or very nominal value based commissions. These brokers typically don’t add any value in the way of professional advice, but instead usually offer access to research data which you must access and interpret yourself. Of course, an investor may incur additional costs such as maintaining a computer and internet connection, and in purchasing information services and computerised trading tools in the hope of enhancing their returns.
Indirect Investment
Many investors gain their share market exposure by investing with professional managers in either unit trusts or through individually managed accounts – generally referred to as “managed investment funds”, or as is more common, simply “managed funds”. The fund manager takes on responsibility for investing and managing your money as per the goal of the fund, and aims to provide returns in the form or income and/or capital growth. Whilst the underlying structure of the various managed investment facilities can differ, one common feature they share is that the fund manager will charge the investor a fee to invest and manage the investor’s money.
Fees
There’s nothing intrinsically wrong with fund managers charging a fee for their services – just like your plumber or dentist. If your fund manager, through exercise of the investment skills of its staff have made you better returns than the market average they deserve to be paid for that service – just like the plumber who unblocks your drain. However, the problem with almost all fund managers, and thus the funds management industry as a whole, is that managers will charge their clients a fee irrespective of whether the investment return is better or worse than average. My personal philosophy is that a fund manager should only make money when the manager has made money for their client by beating the market average. If your funds don’t outperform the agreed upon performance metric, your fund manager shouldn’t get paid – otherwise they are getting paid for adding no value! You wouldn’t pay the plumber who turned up and then incompetently failed to fix a simple blockage – I believe the same should apply to funds management.
Direct investment can be seen to remove one (or more) layers of fees which should – in theory – enhance returns. On the other hand, direct investment, particularly when one takes an active approach rather than a passive approach (a distinction discussed further below) can be quite time consuming and requires constant administration. Realistically, many investors lack the necessary skill or time to successfully invest directly on an ongoing basis. Alternatively, indirect investing through a managed fund frees up an investors time because the investment management decisions have been outsourced to the fund manager. In addition, the tedious administrative tasks will be done by the manager who will produce concise performance statements which you can usually pass on as-is to your accountant at tax time. The downside of course is that all this work by the fund manager typically isn’t done for free.
In summary, both direct and indirect methods of investing in the share market can be equally valid provided the underlying investment strategy used can consistently produce good returns for the investor, with direct investing generally the cheaper option, at the expense of requiring more personal skill, effort and time from the investor.
