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DIY Brokers vs Managed Funds: Which One is Better?

DIY Brokers vs Managed Funds: Which One is Better?
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With investing becoming democratized and an utterly normal way for people to “spend” their money, the question of whether to have your money managed for you or not is becoming increasingly pressing. The general trend seems to be towards DIY brokers, with Robinhood sign-ups absolutely exploding over lockdown, along with an insatiable appetite for cryptocurrency investing. 

Only, this is the issue. Should we be proud that the everyday person is investing, or should we be concerned about a growing gambling culture? With the events seen with GameStop, Dogecoin, and many other phenomena, it’s difficult to argue that much of this retail investing isn’t rooted in gambling. After all, this has somewhat been born out of lockdown boredom – making it a leisurely recreational activity for many with spare money.

So, to keep our feet grounded, we will explore whether or not having our money managed is worth it or not – and if DIY brokers are the way forward but just need to be reframed.

Are Money Managing Firms Worth It?

We will split money management up into a couple of areas to help unpick the pros and cons compared to DIY investing. 

Cost Managed Funds

The cost of a managed fund will depend on what type of management is going on, but generally, we can consider this to be higher than DIY investing.

Actively managed funds will often cost the most, as they require the most human resources. These are funds that are constantly being managed, with assets being bought and sold in order to try to “beat the market”, adjusting and speculating on the ever-changing environment. Generally, you can expect these to cost around 0.75% to 1.25%.

Investment trusts, which are in a sense just closed-ended funds, follow a similar style of costs, where passive ones are much cheaper than the ones actively managed.

Passive funds, often called tracker funds, are funds that aim to deliver returns that are in line with the market. They do this by making investments that represent the market (i.e. many small investments within that market) and thus replicate the returns of that market. These are cheaper because they’re more passive, and so will cost between 0.2% and 0.8%. 

Finally, Robo Advisors are somewhat automated versions of the passive funds (which are also often automated too!) They’re usually in the ~0.25% management fee area. It would certainly not be good value to pay more than 0.25%, as they’re likely to do simple index fund investing just like the others.

Cost of DIY Brokers

One reason behind the popularity of DIY trading is the trend towards commission-free stock and ETF trades. For example, Qtrade is the #1 rated Canadian broker, and whilst there is of course a spread between the buy and sell price, there is no actual commission fee for ETFs.

So, in a sense, there is only one winner here when it comes to cost. You could certainly buy an ETF that tracks the S&P 500 for cheaper than using a fund that manages and replicates the returns of the S&P 500.

However, many of Vanguard’s passive funds are around 0.22% (some simpler ones are even cheaper) – which is very low. And, as we’ll cover below, this may be worth paying for.

Other PROS and CONS of Money Management

We will narrow “money management” down to the notion of a Vanguard Fund so we can be precise in our comparison – and the consensus is Vanguard is one of the cheapest ways to benefit from high performance. So, let’s assume that you’re going to go head to head with this fund with something similar, an ETF from a DIY broker. Because, let’s face it, creating your own would be a nightmare.

Fund vs ETF

Mutual funds do require a minimum amount of investment, which is a downside. However, this is all because of the way that they have fractional ownership unlike ETFs, which means asset allocation is more accurate. In other words, your fund will rebalance more accurately than ETFs. Furthermore, when liquidity is low in the market, ETFs have a tendency to go out of sync with the asset prices they’re replicating.

These are perhaps small differences, but a bigger difference is that Vanguard offers different funds for different needs. The Lifestrategy selection is extremely clear in how it communicates to investors. For those with longer investment time horizons, a Lifestrategy 80 or 100 would be preferred, which means an 80/20 mix of stocks and bonds, or 100% stocks. 

ETFs are a little more manual than this. You’re not likely to receive the same level of bespoke portfolio creation, and whilst some may effectively create their own ideal portfolios from the greater freedom, they may also find paying 0.22% to be worth the management.

Time in the market vs timing the market

Finally, it comes down to the strategy of the investor. If they are looking to invest in individual stocks or more obscure ETFs, then brokers would be the only option on the table. Many will claim that time in the market beats timing the market, though this could be achieved with both a DIY broker or managed fund.

However, what that adage really shines a light on is the type of fund and type of DIY investing. It suggests that as a lot of evidence shows, actively managed funds are not worth the high cost. Many passive funds that return the global average market returns of ~8% a year, in the long run, are outperforming actively managed funds.

Whilst their difference between paying a fund 1% to manage your money vs a DIY strategy of buying zero-commission Tesla shares couldn’t be any more different to each other, the difference between a zero-commission ETF and Vanguard 0.22% fee fund is fairly small.

Should you trade frequently?

If you disregard the “time beats timing the market” notion, then it may be that DIY brokers appear the better option as these allow for frequent trading on your own terms. This is where you can manifest the tips and speculation of Youtubers and friends. This isn’t recommended by most investors and is where we begin to see retail investors venture into gambling.

Whilst high-frequency trading is a real investment strategy executed by large entities, it usually requires high-powered (and costly) infrastructure and software. Not only this, but technical analysis and creating trading algorithms is a lengthy journey, and wouldn’t be considered casual investing.

Thus, if you’re trading frequently (i.e. multiple times per day/week) without a comprehensive strategy, you may want to consider if this is gambling or investing. 

Final Word: DIY Brokers vs Managed Funds

Many experienced investors will tell you that keeping costs low is a key goal. This sounds obvious on the face of it, but if we read between the lines, it may also be inferring that high-cost actively managed funds are simply not worth the cost – even Warren Buffet thinks so.

The real debate comes down to using brokers to build your own portfolio, or allowing a firm to create one for you. We could simplify this to Do you want to be hands-off and welcome convenience, and also, how experienced are you at investing?

There is nothing more hands-off than a passive fund. They will generally be more convenient in meeting your needs and will allow you to switch off thinking about the investment. 

If you’re inexperienced, then it’s worth investing in a managed fund and perhaps doing some relatively smaller trades on the side with a low-commission broker (assuming you’re interested in learning). If you’re already experienced, then there’s no denying you could meet your needs more specifically by building your own portfolio – and it would be slightly cheaper.

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