Should I invest in shares or funds?

Lennon or McCartney? Beer or Wine? Sunset or Sunrise? Life throws up several ‘crossroad’ type questions pushing us down one path or another. The decisions you eventually take are based on many factors from personal taste, experience, motivation, or belief.

The investment world is no different with one of the biggest questions being should you invest your hard-earned cash in shares or funds’? We look at the pros and cons of each style to help you make a more informed choice.

Back in the Swinging Sixties it was just the thing for cool young and old types to own shares. In 1963, according to the Office for National Statistics, ordinary individuals like you and me owned around 54% of UK quoted shares in terms of total value. Over the decades however as fashions, governments and ideas slipped away and that number also changed hitting just 12% at the end of 2020.

In comparison, the Office for National Statistics state that Unit trusts – where investors’ money is pooled into a single fund – have grown from around 1% of share ownership in 1963 to just over 7% in 2020. And Investment trusts – a fund set up as a company listed on a stock exchange – accounted for 1% in 2020.

So, what drives these decisions? Why would an investor invest directly into shares on their own or hold them in a fund with others?

What are shares?

You can buy shares, also known as equities, in companies that are listed on public stock markets like the London or New York Stock Exchanges. By doing this it means that even though you are not drilling for oil or stacking the shelves you can own part of a business such as BP or Tesco. The value of your shares depends largely on how well or badly the company performs but can also be impacted by general economic conditions.

What are funds?

Funds, also known as collective investments, are another way to buy shares in listed companies or other assets such as bonds. Instead of making the decisions yourself, you give your money to a fund manager who ‘pools it’ with cash from other investors. The manager then uses this pot of money to buy a number of shares in different companies. There are different types of funds such as OEICs, unit trusts, investment trusts and ETFs. They are either managed actively – where the fund manager can chop and change stock selections – or passively in that they track or follow a basket of stocks or indices.

The pros of investing in shares

You are in control: it is up to you which shares you buy, where and how many. It could be a top FTSE 100 firm, a tech start-up on the AIM market or even US or Japanese stocks in their respective markets. You have the freedom to buy, hold or sell these shares whenever you like.

Easy trading: public stock markets are open most of the working day meaning that you can buy and sell over your Frosties, playing the guitar to your dog at lunchtime or amidst the tinkling of teacups in the mid-afternoon. One of the most popular ways of doing this nowadays is through an online stockbroker or share dealing platform.

Tax efficient: because you are in charge of how and when you sell your shares you can better control your capital gains tax liabilities.

Dividend income: shareholders may receive regular dividend payments from the companies.

Lower fees: you don’t have to pay the annual fees associated with investing in funds.

Potential for huge gains: because your investment is concentrated in one company, if its share price rockets you will likely make more money than if you had a spread of investments in a fund. In other words, you have the whole cake to yourself!

The cons of investing in shares

Potential for huge losses: because your investment is concentrated in one company, if its share price collapses because of a corporate scandal, economic hit, or just poor performance then you will lose money.

Lack of diversification: you can buy shares in a range of companies and sectors but being truly diversified, and lowering the risk of a financial wipe-out, is harder to do outside a fund.

Time consuming: you need to commit a lot of time to researching companies and sectors, learning to read financial reports, judging future economic trends, and following the markets both here and possibly abroad. It can be a stressful experience and hard to emotionally distance yourself. Your social life of salsa dancing and skittles might have to take a back seat.

Trading fees: you need to consider the cost of fees associated with the buying and selling of shares and any broker commissions.

Volatility: a share price’s life is never smooth. It will rise and fall, sometimes steeply, in line with company performance and the markets if there is economic gloom or confidence around. This will put a lot of pressure on you to buy or sell. At these times you need to stay true to your investment philosophy and goals.

The pros of investing in funds

Diversification: the proverbial eggs in several baskets’ argument. By having a wider spread of shares or assets or themes in a fund – rather than one single company – if the share price of one of the firms in your fund performs poorly, your money could be better protected thanks to gains elsewhere in the fund.

Professional management: fund managers do this for a living, it is their bread and butter although they often prefer Chablis and hummus. They are experienced stock pickers and often have large research departments providing them with up-to-date analysis and information.

No trading fees: you are spared this cost as you are not doing the physical buying and selling of shares. The fund itself still pays trading fees, but as these are spread over a large number of investors you benefit from economies of scale.

Less stress: you don’t have to spend all your waking and sleeping hours worrying about share prices but don’t relax too much. Not all funds are world-beaters and not all fund managers get it right all the time. Best to keep a regular eye on how your funds are performing.

Less research: you still have to do some work finding the fund that most appeals to your investment philosophy or strategy. But not as much as researching individual shares!

Returns: you may receive a regular investment income from some funds in the form of a distribution. This consists of capital gains made from the sale of assets in the portfolio, alongside any dividend and interest income made by the fund’s holdings. You can also make money if the Net Asset Value of the fund has increased when you come to sell.

The cons of investing in funds

Out of your hands: it is the fund manager who makes the stock picks and creates the investment portfolio and theme. This can feel restrictive for a certain kind of investor who sees a stock buying opportunity that the manager doesn’t.

Costs: while you don’t have to pay a trading fee, there are other charges to cover the day-to-day running costs of the fund. These are set out in a fund’s Ongoing Charges Figure (OCF).

Tax efficiency: you don’t have control over when fund distributions are paid into your account making it harder to be tax efficient. However, you can hold most funds in an ISA, which could protect your returns from taxes such as income and capital gains. Pensions are another tax-efficient way to invest.

Trading restrictions: because mutual funds are only traded once a day near the close of markets there are obviously fewer options open to investors. Those who like timing the market, have more of a short-term investment horizon or want more trading windows may find funds too frustrating. However, there is the option of intra-day trading if you invest in listed Exchange Traded Funds and Investment Trusts.

Selection risks: the risks associated with investing in funds are similar to those when you buy shares. The price can go up or down depending on the strength or otherwise of the index, asset, or sector the ETF is tracking.

Star manager: it is easy to be swayed by the past performance of a fund manager and expect their star to keep ascending. Don’t be seduced by a famous name. Judge a manager on their present merits. Think Neil Woodford and even football manager Jose Mourinho. Things can turn sour.

What do you need to consider when choosing between funds and shares?

You should base your decision around key factors such as risk, goals and cost.

Risk: how much risk are you willing to take on in your investment strategy? Investing in individual shares can be higher risk but also typically higher reward. Morningstar figures show that over the last five years US large-cap stock mutual funds have a 16.57% total return. That compares with the 215% share price increase recorded by Amazon, according to Yahoo Finance and the 1303% rise in Tesla shares over the same period. However, clothing firm Gap’s share price, as stated on Yahoo Finance, has been shabbier falling around 52% over the period hit by the pandemic, supply chain challenges and changing consumer tastes. Are you happy to take the risk with individual shares or prefer the comfort of more diversified funds?

Goals: what are your investment goals? If you follow the Bestinvest mantra of being a long-term investor, then looking at the steady and safer world of funds might be more suitable. If you have more of a short-term focus, then individual shares might be your thing. It may also depend on what life stage you have reached. If you are a parent with young kids and a job, then it could be hard to give the physical and emotional time needed for individual share trading. If you are younger with no commitments or retired and bored with staring at tomatoes, then share dealing may be too exciting to resist.

Costs: you need to factor in various costs such as fees. What can you afford?

So now you’ve weighed up the pros and cons of each, what do you think? Or perhaps the answer is a bit of both.

How Bestinvest can help you

If it’s funds you want, we have big choice available plus detailed fund factsheets and guides to give you investment inspiration.

If it’s shares, did you know it’s just £4.95 a trade with us?

We also offer free coaching with qualified financial planners to give you the opportunity to chat about your investments and financial plans.

Important information

This article is solely for information purposes and is not intended to be, and should not be construed as investment advice. Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.  The opinions expressed are made in good faith, but are subject to change without notice.

You should always remember that the value of investments can go down as well as up and you can get back less than you originally invested. Past performance is not an indication of future performance.