Managed Funds Vs Direct Ownership

Most of us will have our precious superannuation nest egg invested in managed funds. This is common and, for those with smaller balances, there is nothing wrong with this. However some problems can arise with larger balances and there comes a point where direct ownership becomes more advantages.

 

What is a managed fund and what are some of the downfalls?

A managed fund is an investment option (commonly spread across several investment classes) where your money is pooled with others and used to buy investments.

The biggest downfalls of managed funds include:

1. Lack of transparency

Most people have a core fund they’ve invested in which will be called something like ‘Core balanced’ or ‘Balanced Growth’. However, very few actually know what this means or where there money is even invested.

This unknown creates magnified discomfort when markets are volatile or falling.

2. Fees

Managed funds charge management fees which are built into the fund itself and are charged on top of any administration or adviser fees you pay.

Again, most of us will have no idea of what fees we are paying and many people we talk to believe they aren’t being charged anything due to the ‘hidden’ nature of these fees.

3. Lack of Flexibility

Diversified managed funds are run according to a certain mandate i.e. must have a certain % in each asset class.

Whilst this provides diversification it can limit you in your choice of investments and/or timing of investing.

Each time we add funds to our super the funds are automatically invested according to our current mix of investments without any thought given to current state of the economy or the markets.

4. Tax inefficient

Management fees charged by managed funds are NOT tax deductible

Most managed funds do not generate the tax credits available to investors – these can add to several thousands of dollars EVERY year in missed returns.

Losses in managed funds cannot be carried forward to be used against future gains from other assets.

5. After tax returns

Managed funds also distribute your total return each year to you as one return.

Capital gains AND income returns are distributed to investor every year

This means we pay tax on the whole return every year rather than just paying tax on the income and allowing any growth to accumulate over time.

The above disadvantages of managed funds can add up to many thousands of dollars a year when compared against a portfolio of self-owned investments.

Self-owned doesn’t mean you have to have a self-managed super fund nor does it mean you have to look after your investments yourself.

 

What are the advantages of direct ownership?

1. Tax efficient

Unlike an investment into managed funds, directly held investments can attract tax credits. These become extremely valuable (especially when you retire) and can be worth thousands of $$ every year.

Rather than paying management fees within a managed fund any fees payable on a directly held portfolio are tax deductible.

2. After tax returns

When investments are held directly the income generated is separated from any growth in the portfolio before tax is levied.

Growth in share values for example is not taxed until shares are ultimately sold

Any losses made on investments held directly can be carried forward and used to offset gains in future years.

 3. Transparent and flexible

Directly held investments allow you to see exactly where your money is invested at ANY point in time.

This transparency is comforting in times of volatility e.g. if your core growth fund fell by 10% you tend to be more concerned than if your holding in CBA fell by 10% because we understand the CBA business and know we are still receiving dividends etc.

 

Managed funds have a place – we use them for small balances and to invest in asset classes such as international shares where we don’t have the expertise to pick specific shares.

In general however managed funds are tax inefficient, inflexible and lack transparency and, for those with reasonable investment balances, direct ownership has some compelling advantages.

 

 

Knight Financial Advisors Pty Ltd is a Corporate Authorised Representative of NKH Knight Holdings Pty Ltd (AFSL 438 631) ABN 30 163 152 967. The information contained herein is of a general nature only and does not constitute personal advice. You should not act on any recommendation without considering your personal needs, circumstances and objectives. We recommend you obtain professional financial advice specific to your circumstances.