ETFs vs. Investment Trusts: How To Choose the Best Investment for You

When it comes time to invest your hard-earned money, there are a number of options to consider. Two common investment options that offer diversity and the potential for a good return on your investments are exchange-traded funds (ETFs) and investment trusts.

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Learning what they are and their key differences will help you determine whether either option is suitable for your financial investment strategy

What Is an ETF?

An ETF is a diversified investment security that is bought and sold on national stock exchanges. It can track the performance of specific market indexes, sectors, assets, commodities or a combination of these investments. Investors buy ETF shares for multiple reasons, such as generating income, hedging to offset portfolio risk and protecting against market volatility.

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What Is an Investment Trust?

An investment trust is a closed-end trust that involves multiple investors buying into a portfolio together. A professional fund manager invests the pooled resources to purchase a combination of assets, such as stocks, bonds or real estate. The value of the assets in the trust determines the price of the shares, and the number of shares is fixed.

Differences Between ETFs and Investment Trusts

ETFs and investment trusts differ in key ways. In terms of structure, ETFs are open ended, while investment trusts are closed ended. Open ended means the number of available shares can fluctuate as opposed to the fixed number of shares in a closed trust.

While both ETFs and investment trusts have managers, investment trusts require a much more active approach. Investment fund managers must use the available assets and adapt to market conditions. On the other hand, because ETFs track sectors or indexes, they require much less oversight. This difference also affects the cost structure, with investment trusts often requiring higher fees.

The timing for acquiring shares also differs. You’ll be able to buy and sell shares of an ETF throughout a typical trading day as if it were a stock. However, you can trade shares of an investment trust only once per day, at the end of a trading day.

Advantages and Disadvantages of ETFs

ETFs are attractive options for all types of investors. Advantages of buying into ETFs include:

  • Low cost: Because ETFs are often passively managed, managers require lower fees. This means more of your initial investment will go toward the actual fund, increasing your returns.
  • Liquidity: ETFs are available on national stock exchanges, making it easy for investors to cash out quickly if they need to. 

There are also drawbacks that come with putting your money into an ETF. Some of the major disadvantages of investing in an ETF:

  • Tracking errors: ETFs track indexes or market sectors but aren’t always accurate. Tracking errors can result in small or large differences, which is an added risk for investors.
  • Less control: ETFs are bundles of stocks that follow the fund’s aim. Certain ETFs that interest you may include stocks that you don’t want to invest in.

Advantages and Disadvantages of Investment Trusts

Investment trusts have a different set of advantages that may better suit your needs. Some of the benefits of purchasing shares of an investment trust:

  • Active management: Professional investment managers with real-time data and analysis make decisions on your behalf in an attempt to get the best possible results.
  • Discounts and premiums: Because there are a limited number of shares available in an investment trust, the demand of new investors can boost or lower the value. Depending on the demand, you may be able to buy shares at a discounted price or sell them at a premium.

It’s vital to look at the downsides of investment trusts also. Some other factors to consider before investing in one include:

  • High fees: Just as active management can be a positive, it also means paying more in fees. Having fees taken out of your investment results in less available money to generate returns.
  • Low liquidity: Investment trusts aren’t as liquid as other investment vehicles. You can buy and sell investment trust shares only at the end of a trading day. High volatility and investor demand can also make it harder to sell at the price you want.

How To Choose Your Investment

Some specific aspects may influence your decision to invest in ETFs or investment trusts. It’s a good idea to consider how these factors affect you before investing:

  • Risk tolerance: Taking on more risk than you can handle can have detrimental side effects. If you’re constantly worried about losing your investment, you may feel high amounts of stress, anxiety and depression. And you might lose money on top of that.
  • Age: Younger investors can more often take bigger risks because they have more time to make their money back. Older investors may want to be more conservative. 
  • Investing goals: Setting clear long- or short-term investment goals, such as saving for a down payment on a house or making enough to take a vacation, can determine how you choose to invest.
  • Knowledge: It is important to be honest with yourself about your level of investing knowledge. If you’re not sure which investment is best for your goals and financial situation, you should consider seeking professional advice.
  • Liquidity: If you may need to quickly convert your assets into cash, liquidity can play a large role in your decision on how to invest.

Both ETFs and investment trusts are excellent options for investors who want to diversify without worrying about managing their portfolios. ETFs offer a safer choice if you’re interested in tracking a specific index or sector without actively managing your portfolio and avoiding high management fees. On the other hand, investment trusts can be riskier but also can lead to better returns.

More From GOBankingRates

This article originally appeared on GOBankingRates.com: ETFs vs. Investment Trusts: How To Choose the Best Investment for You

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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