While purchasing property has long been a popular investment choice in Australia, with many believing…
Just like most people, you want to secure your financial future and achieve long-term growth. However, you can’t quite make up your mind to opt for direct or indirect shares.
Yes, there are two categories of share ownership: direct ownership – where you buy shares of a company, or Indirect ownership – where you buy units in a managed investment fund that invests in shares.
Do direct or indirect shares impact your profit differently?
Just like you, investors recognise the importance of diversifying their portfolios to secure their financial future. However, the decision to focus on direct or indirect share ownership can significantly impact investment outcomes.
Whether you opt for direct vs indirect shares, understanding their differences is pivotal in shaping your investment strategy.
Key Differences Between Direct vs Indirect Shares
Level of Control and Decision-making
Diversification and Risk Management
Costs Associated with Each Investment Approach
Pros and Cons of Direct Shares
Summary: Direct vs Indirect Shares
Direct shares refer to individual stocks that investors purchase on their own behalf – making them a direct owner of shares of a company.
Imagine that you own shares in a company. This gives you voting rights and a voice in the decision-making of the company.
Similarly, investors with direct share ownership can influence how a company functions and choose the board of directors to manage the company’s goals, resources, and executive roles.
Direct ownership provides investors with portfolio transparency and the freedom to modify assets as needed.
Direct shareholders can be individuals or entities, such as parent companies, that hold more than 50% of the shares in a subsidiary company. Direct ownership can also provide investors with tax planning benefits, as they can control their capital gains or losses.
Now there are different types of direct shares that you can acquire. Some of these include:
ASX Direct Shares: These are shares offered by companies listed on the Australian Securities Exchange (ASX). Investors can buy and sell shares in these companies through trading platforms that provide access to a wide range of ASX direct shares with competitive brokerage rates.
Blue Chip Shares: These are shares in well-established and financially solid ASX-listed firms that are known for their consistent business performance and frequently pay dividends. Blue chip stocks are often highly liquid and easily purchased and sold on stock exchanges, giving investors a measure of ownership based on their investment.
Sector-Specific Shares: Investors may also consider investing in shares of companies trading within specific sectors such as technology, healthcare, finance, or utilities. For example, Australian shares in the utilities sector may include companies like APA Group and Meridian Energy Ltd, offering investors exposure to this specific industry.
Direct Stock Purchase Plan (DSPP): Also known as a Dividend Reinvestment Plan (DRP), it allows you to buy stock directly from a company, sometimes at a discount, and does not require brokerage fees. DRPs are not purchased through the ASX. DRPs are offered by individual companies and can be accessed through their share registry or a financial institution.
In contrast to direct shares, indirect shares are purchased through a fund or trust, with fund managers in charge of managing managed funds and ETFs.
Managed funds allow investors to buy a diversified stock portfolio managed by a professional fund manager. This lets investors benefit from fund manager skills and portfolio diversity.
However, all the decision-making rests upon fund managers, leaving investors with minimal influence over which shares to buy and how much of each share. When compared to successful individual stock selection, indirect ownership may yield lower returns.
In Australia, there are two ways to indirectly hold shares: through managed funds or trusts. And there are four different types of indirect shares.
Managed Funds: These are investment funds managed by professional fund managers who pool money from multiple investors to invest in a diversified portfolio of assets, including shares, bonds, and property. As an investment product, a managed fund offers investors the benefits of diversification, professional management, and access to a range of investment options.
Exchange-Traded Funds (ETFs): These are investment funds that trade on stock exchanges like shares, providing investors with exposure to a diversified portfolio of assets. ETFs can track a specific index, sector, or asset class, and can offer investors the benefits of diversification, low costs, and flexibility.
Superannuation Funds: These are retirement savings funds that invest in a range of assets, including shares, bonds, and property. Superannuation funds offer tax benefits and long-term investment growth opportunities, making them a popular choice for retirement savings in Australia.
Direct Shares through a Trust or Partnership: Investors can also indirectly own shares through a trust or partnership, where the trust or partnership holds the shares on behalf of the investor. This structure can provide tax benefits and asset protection, but may also have restrictions on changing invested money. However, trustees administer assets for beneficiaries under trusts. The trustee holds company shares, while the beneficiaries receive dividends and capital gains from selling shares.
It’s important to understand the differences between investing in direct and indirect shares so that you can make the right investment choices. Ultimately, one’s preferences will be highlighted by the key differences between direct and indirect share ownership.
Level of Control and Decision-making
Direct shares and indirect shares offer different levels of control and decision-making within a company.
Direct Ownership Empowers Control
Direct ownership gives individuals complete voting rights, allowing them to participate in critical corporate decisions and actively shape the company’s trajectory. This control empowers direct shareholders to have a direct say in its management and strategic direction.
Direct ownership facilitates a hands-on approach, providing investors with a direct voice in company affairs. Direct shareholders wield their voting rights and influence management, actively shaping the company’s course.
Indirect Ownership Shifts Control Dynamics
Indirect ownership through funds or trusts results in a shift in control dynamics, as investors relinquish their direct voting rights and delegate decision-making authority to fund managers. These managers act as proxies, executing investment decisions on behalf of investors, and transferring control over specific stocks held within these funds or trusts.
Indirect ownership through funds or trusts leads to a reduced level of direct involvement. Investors entrusting their assets to funds or trusts concede decision-making to professionals, resulting in a diminished influence over specific stocks and strategic decisions within their investment portfolio.
Trade-Off Between Control and Convenience
The trade-off between control and convenience is evident in both ownership models.
Direct ownership promotes active participation and control, while indirect ownership through funds or trusts provides convenience but dilutes individual influence and decision-making authority in favour of professional management.
Both paths have distinct implications for investors’ engagement and influence within their investment portfolios.
What Are You More Inclined to Do?
Embark on a journey of investment tailored to your preferences by considering the following checklist. As an investor:
- I want full control over my investment decisions.
- I prefer having voting rights and influencing company decisions.
- I’m comfortable taking on the responsibility of decision-making.
- I’m okay with limited control over investment decisions.
- I understand that fund managers will make decisions on my behalf.
- I’m comfortable delegating decision-making authority to professionals.
If you are inclined towards the first three statements, indicating a preference for active involvement and control over voting rights and strategic decisions, direct shares may align with your investment approach.
Conversely, if you tend to relate more to the latter statements, which suggest a preference for professional management and limited involvement in decision-making, then you may find indirect shares to be a more suitable option for your investment strategy.
Diversification and Risk Management
Diversification plays a pivotal role in managing investment risk, presenting contrasting scenarios between direct and indirect share ownership.
Individual stock selection is required for direct shares. While direct ownership may generate larger returns, it also carries a higher risk due to concentrated exposure resulting in a lack of diversification.
Concentrating an individual’s portfolio on a few stocks exposes them to the specific fortunes and risks of those chosen companies’ share prices. A lack of diversification increases exposure to market swings and individual company performance, thereby amplifying overall investment risk.
In contrast, indirect shares, which are often held through managed funds, provide a diverging risk management strategy. These investment vehicles curate portfolios that include a diverse range of stocks.
A diversified composition effectively spreads the investment across multiple assets, minimising the impact of any single stock’s bad events. As a result, the risk associated with individual assets is mitigated by the wider pool of holdings, lowering overall risk exposure. However, prospective profits may be moderated.
Portfolio Composition Difference
The main difference is how the portfolios are put together: direct shares typically focus on a smaller group of individual stocks, which raises risk; whereas indirect shares, which are made possible by managed funds, use diversification to lower risk by spreading investments across many assets.
In essence, the option between direct and indirect ownership is also influenced by the investor’s risk tolerance. Investors must consider these risk-reward dynamics to match their investment strategy to their risk tolerance and financial goals.
What’s Your Level of Risk Tolerance?
Use this short checklist to help find out risk tolerance and investment inclination. As an investor:
- I prefer selecting individual shares for my investment portfolio.
- I understand that focusing on individual stocks may increase risk due to a lack of diversification.
- I’m comfortable with the potential risks associated with concentrated investments in specific companies.
- I value diversification across multiple stocks within a fund.
- I recognise that diversification can help lower risks associated with individual assets.
- I’m open to relying on fund managers for diversified investment choices.
If you are inclined towards the first three statements, indicating active involvement in strategic decisions and confidence in your capability to manage risks, direct shares may be a good fit for your investment strategy.
In contrast, if you tend to rely on the latter statements, which indicate a desire for professional management and limited engagement in decision-making, indirect shares may be a better fit for your investment approach.
Costs Associated with Each Investment Approach
Both direct and indirect share ownership have costs and fees that may significantly affect your net income.
Direct share ownership involves individual buying, selling and management, often leading to higher transaction costs and brokerage fees. Each share purchase incurs separate fees, potentially accumulating significant costs, especially with frequent trading or smaller investments. Additionally, managing a diverse portfolio of individual stocks may demand ongoing time and research expenses for active management.
In contrast, indirect share ownership through managed funds typically carries management fees. These fees cover operational and professional management costs but are usually predictable, and calculated as a percentage of total assets. Managed funds benefit from pooling investors’ funds, potentially reducing transaction costs compared to individual stock purchases. Moreover, investing in managed funds provides access to a diversified portfolio within a single investment, spreading costs across multiple holdings.
Comparison of Cost Implications
The comparison between direct and indirect ownership revolves around transaction fees, brokerage charges, and ongoing management expenses. Direct share ownership often incurs higher transaction and brokerage fees due to individual stock purchases, while indirect ownership through managed funds may involve management fees but could offer cost efficiencies through diversified portfolios and shared expenses.
Investors should consider these cost implications alongside their investment goals, desired engagement level, and tolerance for expenses to make an informed decision that aligns with their financial strategy.
Are You Confident in Overcoming Costs & Fees?
Use this short checklist to find out if you find costs and fees minimal or significant. As an investor:
- I’m aware that individual stock buying might lead to higher transaction costs and brokerage fees.
- I recognise that each share purchase incurs separate fees, which can add up significantly.
- I’m comfortable with the potential costs involved in frequent trading or managing smaller investments.
- I understand that managed funds may have management fees, usually calculated as a percentage of total assets.
- I’m aware that pooled investor funds in managed funds might lead to lower transaction costs.
- I understand that costs are spread across multiple holdings within a managed fund.
If you respond positively to the first three statements, which means you like being involved and having control over voting rights and strategic choices and are prepared to pay potentially higher transaction costs, then direct shares may be a good way for you to invest.
Indirect shares may be a better choice for your investment strategy if you tend to agree with the last three statements, which suggest that you may prefer to pay for professional management and have little say in decisions.
Other Factors to Consider
Other factors that differentiate direct and indirect shares in Australia include transparency, liquidity, portfolio valuations, and capital gains tax.
Direct shares offer transparency of portfolio holdings, while indirect shares through managed funds offer professional expertise in stock selection and portfolio management.
Ultimately, the choice between direct and indirect share ownership depends on individual financial objectives, risk appetite, and investment goals.
So, which one is better?
The answer is neither. It’s essential for investors to carefully evaluate the advantages and disadvantages of each option in line with their financial goals and risk tolerance.
Understanding the pros and cons of direct share investing is essential for informed decision-making.
While direct shares provide control and potential for higher returns, they require time and knowledge, and investors face the risk of concentrated exposure and market volatility.
By weighing these factors, investors can tailor their strategy to align with their financial goals and risk tolerance.
One of the main benefits of direct shares is that investors have complete control over their investments. They can choose which companies to invest in, how many shares to purchase, and when to sell. This level of control allows investors to tailor their portfolios to their specific investment strategy.
2. Capital Gains
Direct shares can provide investors with the potential for capital gains. If the price of a stock rises, investors can profit by selling their shares. This can be a significant benefit for long-term investors who are willing to hold onto their shares for an extended period and benefit from their time in the market.
Many companies pay cash dividends to their shareholders. These dividends can provide investors with a steady stream of income, which can be reinvested to purchase more shares.
4. Direct Stock Purchase Plans
Some companies offer direct share purchase plans, which allow investors to purchase shares directly from the company. Investing in a company without incurring brokerage fees can be a cost-efficient approach.
When investors purchase direct shares, they may be required to pay brokerage fees. These fees can add up over time and reduce the overall return on investment.
Direct shares can be risky investments, as the price of a stock can fluctuate significantly in a short period. This can result in significant losses for investors who are not prepared to weather the ups and downs of the stock market.
3. Lack of Diversification
Investing in individual stocks can be risky because it lacks diversification. If an investor only holds shares in one or two companies, they are exposed to the risks associated with those companies. This can be mitigated by investing in a portfolio of stocks, but this requires more time and effort than investing in a managed fund.
4. Time and Effort
Investing in direct shares requires time and effort to research companies, monitor the stock market, and make informed investment decisions. This can be a significant barrier for investors who do not have the time or expertise to manage their investments.
Knowing the pros and cons of investing in indirect shares investing is crucial for informed decision-making.
While indirect shares provide a diversified approach that minimises risk, investors should be aware of potential management fees and the trade-off of relinquishing direct control to fund managers.
This understanding enables investors to tailor their strategy to align with their risk tolerance and financial goals within the Australian investment landscape.
Indirect shares, often obtained through managed funds or exchange-traded funds (ETFs), provide investors with exposure to a diversified portfolio of stocks, reducing the risk associated with investing in individual companies.
2. Professional Management
Investing in managed funds allows investors to benefit from the expertise of professional fund managers who make investment decisions on behalf of the investors. This can be particularly advantageous for individuals who may not have the time or expertise to actively manage their investments.
3. Lower Minimum Investment
Some managed funds and ETFs have lower minimum investment requirements compared to purchasing individual stocks, making indirect shares more accessible to a broader range of investors.
4. Dividend Reinvestment
Many managed funds and ETFs offer dividend reinvestment plans, allowing investors to automatically reinvest dividends to purchase more shares, thereby compounding their investment over time.
Investing in managed funds or ETFs typically involves management fees and other expenses, which can reduce the overall return on investment. It’s important for investors to carefully consider the fee structure and its impact on their investment returns.
2. Lack of Control
When investing in managed funds, investors relinquish control over the specific stocks and assets in the portfolio to the fund manager. This lack of control may not align with the preferences of investors who prefer to have a hands-on approach to their investments.
3. Overlapping Holdings
In some cases, investors may find that their indirect shares overlap with their existing direct shareholdings, leading to a lack of diversification and potentially increasing their overall risk exposure.
4. Market Dependency
The performance of indirect shares is dependent on the overall market conditions and the decisions made by the fund managers. Economic downturns or poor fund management can negatively impact the value of indirect shares.
Choosing between direct and indirect shares can be a challenging decision for investors. Here are some factors to consider when making this decision:
1. Investment Goals
The choice between direct and indirect shares should align with an investor’s investment goals. For example, if an investor is seeking to invest in a specific company, direct shares may be the better option. On the other hand, if an investor is seeking diversification, indirect shares may be more suitable.
2. Risk Tolerance
Direct shares can be riskier than indirect shares due to the potential for significant fluctuations in share prices. Investors with a higher risk tolerance may prefer direct shares, while those with a lower risk tolerance may prefer indirect shares.
Direct shares may involve brokerage fees, while indirect shares may involve management fees. Investors should carefully consider the fee structure and its impact on their investment returns.
If you’re comfortable with potentially higher transaction costs and brokerage fees associated with individual stock purchases, direct shares could work.
If you prefer predictable management fees and potential cost efficiencies from diversified portfolios, indirect shares through managed funds might be more appealing.
4. Time and Expertise
Direct shares might be preferable if you have the time, interest, and expertise to research and manage individual stocks actively. If you lack the time or knowledge for extensive stock analysis and prefer professional management, indirect shares through managed funds might be a better fit.
Direct shares provide investors with more control over their investments, while indirect shares involve relinquishing control to fund managers. Investors should consider their level of involvement in managing their investments.
6. Portfolio Size
If you have a smaller portfolio size and wish to concentrate investments in select companies, direct shares could cater to your preferences. If you seek a broader and more diversified investment portfolio, particularly with limited capital, indirect shares through managed funds might offer better diversification possibilities.
7. Diversification Preference
If you’re content with a concentrated portfolio of individual stocks and believe in their potential, direct shares might suit your preference. If you value diversification across multiple assets to spread risk, indirect shares through managed funds could align better with your diversification goals.
8. Investment Horizon
Direct shares may be more suitable for long-term investors, while indirect shares may be more suitable for short-term investors who require liquidity.
9. Market Conditions
The performance of direct and indirect shares is dependent on the overall market conditions. Investors should consider the current market conditions and the potential impact on their investments.
10. Long-Term vs. Short-Term Outlook
If you have a long-term investment horizon and are willing to hold onto individual stocks, direct shares might suit your strategy. If you prefer a more flexible investment approach or have a shorter investment horizon, indirect shares through managed funds might offer more versatility.
Direct shares provide control, the potential for higher returns, and the ability to tailor portfolios, but come with higher risks and require active management.
Indirect shares, obtained through managed funds or ETFs, offer diversification, professional management, and lower minimum investments, yet involve management fees and a loss of control.
Investors should consider factors such as investment goals, risk tolerance, fees, time and expertise, control preferences, portfolio size, diversification goals, investment horizon, market conditions, and long-term vs. short-term outlook when choosing between the two.
Ultimately, there’s no universal answer, and the decision should align with individual preferences and financial strategies.
Ready to Build an Investment Portfolio?
While investing can seem complicated and time-consuming, it doesn’t have to be that way with knowledge and expert guidance. Whether you’re young or old, it’s never too late to start investing for your future.
Need investment advice? Coastal Advice Group is here to help you tailor your investment plan and build your portfolio. Our experienced financial advice team can help you establish direction for your investments to achieve your financial and lifestyle goals.