1. Fund, ETF or individual shares: what actually changes

Costs 4: Funds, ETFs and products

You can buy exactly the same index in three different ways, and what separates them is not what you buy but how the purchase is executed, when the price you pay is struck, and what each one allows you to do afterwards. That 'afterwards' decides more money than any table of charges would suggest.

Two wrappers for the same idea

An investment fund and an ETF are, in essence, the same legal creature: a collective investment scheme that pools the money of many unitholders, buys a portfolio with it and divides ownership into units. What changes is the channel by which you get in and the channel by which you get out.

• In a traditional fund you are not buying from anybody. You hand money to the fund manager and the fund manager creates new units for you. Nor do you sell to anybody when you leave: the fund manager redeems you and those units cease to exist.
• In an ETF (an exchange-traded fund) you buy and sell on an organized market, from and to another investor, exactly as you would a share. The fund manager plays no part in your trade; it learns of the aggregate balance, not of you.

Everything else hangs off that difference of channel.

The single daily price against the continuous one

The traditional fund is executed at net asset value (NAV): the fund manager adds up what every asset in the portfolio is worth at the close, subtracts expenses and liabilities, and divides by the number of units. Out comes a single number a day, and everybody who gave an instruction that session gets in or out at that number, whatever the hour. What is more, that price is known after you have given the instruction: when you ask to subscribe, you still do not know at what price you will be subscribing.

The ETF trades continuously. You have a price on screen at every moment, you can place a limit order, see the spread and decide. In exchange, that price is not the net asset value: it is what another investor is willing to pay you, and the gap between the two is a cost that level 2 already handled under spread and slippage. The next module explains the mechanism that keeps that gap from running away.

The consequence is an uncomfortable one to accept: for a long-term investor, continuous execution is more of a temptation than an advantage. Being able to sell at half past eleven in the morning serves a trader and harms almost everybody else.

Entry minimums and regular contributions

An ETF is bought in whole shares, so the theoretical minimum is the price of one share. The real minimum, though, is set by your broker: if it charges a flat commission of, say, three or five euros an order, paying in 100 euros a month means handing over between 3% and 5% on the way in every single time. The traditional fund works in amounts rather than units, and admits fractions of a unit; many accept automatic contributions from small sums with no subscription fee. For somebody who pays in little and often, that asymmetry usually weighs more than twenty basis points of difference in the TER.

Pulling the other way, the institutional classes of a fund, the ones with the lowest fees, often demand six- or seven-figure sums, and the retail investor ends up in a more expensive class of the very same product. Always compare the class you can genuinely buy.

What changes in Spain: the traspaso

Spain has a quirk of its own that sometimes settles the whole question. The rules of Spain's personal income tax (IRPF) allow you to move money from one investment fund to another without paying tax on the gain built up so far: the tax is deferred until you finally redeem into your bank account. You can change fund manager, strategy or index without the tax authorities stepping in along the way.

ETFs were shut out of that deferral regime from 2022 onwards. Selling one ETF to buy another is a sale with every tax consequence a sale carries, even though the money never leaves the broker.

Two warnings. One: tax rules change and depend on your personal circumstances; this is general information, not tax advice. Two: deferral is not exemption. You have not saved the tax, you have postponed it, and in the meantime that money carries on working inside the investment.

When individual shares are worth the trouble

Building the portfolio yourself does away with the management fee, and that is no small thing. But it only pays off if three conditions hold at once: that the number of positions is manageable, that your broker does not charge enough per order to eat the saving, and that you do not need to rebalance often. Replicating an index of 500 securities by buying 500 shares is an exercise in arithmetic against yourself: every dividend has to be reinvested, every change of composition has to be executed, and every trade pays a spread.

Individual shares make sense when that is exactly what you want: specific positions held out of conviction, a portfolio of ten or fifteen securities, fine control over which capital gains you crystallize and when. They stop making sense the moment your aim is simply to own an entire market.

A real case: the fund nobody wanted to buy

The first index fund open to the ordinary investor was the Vanguard First Index Investment Trust, launched by John Bogle in 1976 and later renamed the Vanguard 500 Index Fund. Its initial offering set out to raise some 150 million dollars and came in near 11: less than a tenth of the target. The industry called it 'Bogle's folly'. At the time the norm in the United States was an entry fee that could reach 8.5% of the amount invested, so somebody putting in 10,000 dollars started with 9,150 at work.

The first exchange-traded fund on the S&P 500 did not arrive until 1993, seventeen years later. Cheap indexing was not born with the ETF: it was born with a traditional fund, and what the ETF mainly added was another way of getting in and out.