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What Investment Is Best For You?
Investors that have neither the time nor the patience to actively manage their money have options. They can hire a money manager, a hedge fund manger, or invest in a mutual fund or an exchange-traded fund (ETF). But how is an investor to know which route is the best option? There are several things to consider when deciding how to have your money managed - if it is managed at all. Read on for some food for thought.
Starting Costs
An important consideration for many investors is how much it will cost to get into a particular investment. ETFs can theoretically be purchased one share at a time, so the minimum investment is generally negligible. However, many mutual funds have minimums to open an account. To many people, particularly younger investors, the typical $500-$1,000 or more initial deposit a lofty initial investment. (For more insight, see Start Investing With Only $1,000.)
Hedge funds generally have an even higher threshold. Many hedge funds require that their investors own up to $5 million in investments and have a minimum net worth and/or a sizable income stream, typically in the $300,000 range. Some funds have an even higher threshold. (If you dont have the large capital needed to invest in a hedge fund, read Can You Invest Like A Hedge Fund?)
Costs
ETFs carry transaction costs that vary depending on the broker the investor uses. However, in many cases, the total costs are quite small - usually less than 2% of the total amount invested. Meanwhile, investment advisory services and money management firms typically charge 1- 2% of the clients total assets per year in management and advisory fees. On top of that, brokerage fees are typically charged; therefore, the annual returns an investor must obtain to break even can easily top 5% or more per year. (For more, see Dont Let Brokerage Fees Undermine Your Returns.)
Mutual funds can also levy pretty large fees. And while they may vary depending on how the fee structure is laid out, funds by law can charge a front-end load of up to 8.5%, which can be an enormous drag on profits for years. (To learn more, read Stop Paying High Mutual Fund Fees.)
Hedge funds typically charge annual management fees of 1-2% and then retain 20% of the profits an investor earns. According to Barclay Group, a firm that tracks hedge fund costs, the average management fee in 2005 was 1.56%. In that same year, the average performance fee was 19.6%. Some hedge fund managers charge even more for their services.
In any case, the trick is to figure out whether these fees are truly worth it. In some cases, a firm that charges high fees might also generate very high returns for its investors. However, this is not always so, and in most cases, high fees just erode investors returns. (For related reading, see Benchmark Your Returns With Indexes.)
Investment Horizon
Because ETFs are traded on the major stock exchanges and the transaction fees are generally inexpensive, an investor can trade in and out of them with relative ease. However, mutual funds, because they often contain redemption fees, and/or large front-end loads, are usually considered longer-term investments. (For related reading, see When To Sell A Mutual Fund.)
Hedge funds are also considered to be longer term investments because redemptions are typically only allowed in certain quarters - and sometimes only with advanced written notice. In fact, some hedge funds have extended multi-year lock up periods.
When looking for the right investment, investors must realize the advantages and limitations of each investment vehicle prior to becoming involved.
Risk Tolerance/Hand Holding
In many cases ETFs track or mimic major indexes, such as the S
