Equity ETFs are a means of investing in a basket of shares in different companies through a single investment vehicle. For example ,the Ashburton 1200 ETF gives investors exposure to over 1200 shares. Alternatively, to this you could buy the shares you want exposure to directly without an ETF and get exposure to the equity market this way. This brings us to the question, between these two methods which is the most way effective to get exposure to the equity market? The short answer is, it depends. Choosing to invest in an equity ETF or purchase shares directly from the market will depend on your financial goals and investment strategy. The purpose of this article is to consider some metrics and use this information as a guide when deciding if an equity ETF or a direct equity investment is the most applicable for you.
When you invest in an ETF you will have to pay a fee which is demarcated in the total expense ratio (TER), and depending on the broker or financial institution that you purchase the ETF through you may have to pay an additional transaction fee. If you wish to learn more about the different fees associated with an ETF have a look at the following link:
Some brokers have a 0.00% transaction costs, so in some instances, you can avoid the transaction costs. However, most brokers charge a fee and this can be as low as 0.20 %, it depends on the financial institution.
When you purchase individual shares you have to pay a transaction fee, that is subject to the broker and you have to pay a securities transfer tax. The securities transfer tax is like the VAT for financial securities, and you cannot avoid it. The securities transfer tax is charged at a flat rate of 0.25%. However, unlike in the case of an ETF for shares you do not have to pay an annual TER.
So let us look at an example to see how these figures compare and can positively impact your investment vehicle. In this example, person C wishes to invest R100 000 in 2020. He is deciding on whether to buy ETF 77C or to invest in stocks of company Gt, company Yt . Company Jt and company Rt. The ETF has a TER of 0.68% and the broker he wishes to transact with charges a 0.20% of the purchase price as a transaction fee. The same transaction rate applies to if he purchases shares.
Therefore if we are to compare the costs in a table this is how it will look:
These are the costs for the first year of investment. However, if C wishes to hold onto the ETF investment over a long period, he will have to pay TER cost for each year he holds the investment.
From the chart we can see that even though an ETF is exempt from security transfer tax, it incurs higher costs than when you individually purchase shares directly. Perhaps this is made up for in the tax efficiency of ETFs in comparison to shares.
2. Tax efficiency
The benefit that you get with ETFs that you do not get with stocks, is the that ETFs can be allocated to your tax free saving account and stocks cannot. A tax free saving account will grant you the benefit of saving a lot of money from your investment portfolio as you will not be liable for any tax costs such as dividend withholding tax and capital gains tax. You can learn more about this using the following link :
This is where stocks have the upper hand, by purchasing shares directly you have full reign on the composition of your investment portfolio. This is not the case when you invest in an ETF. When you invest in an ETF you cannot exclude shares or assets from the ETF in which you invest in. You also cannot change the composition of the ETF to satisfy your taste. However, with this said this can be the advantage of an ETF. With ETFs you do not have to be heavily reliant on your financial skills as you are given a pre-selected basket of assets which have been selected by a qualified fund manager who has a vested interest in the fund performing well. In order for you to successfully craft an investment portfolio through the direct purchasing of shares you will be more reliant on your financial skills, and therefore may require a more comprehensive understanding of the financial markets if investing in shares, oppose to investing in ETFs.
These are some of the things you can consider when deciding which methods are most effective in giving you exposure to the equity market. You can always choose to combine both methods and have an investment portfolio that consists of ETFs and shares.