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.

Tutorial: Investing In The Money Market

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 don't have the large capital needed to invest in a hedge fund, read Can You Invest Like A Hedge Fund?)

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 client's 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 Don't 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&P 500. While risk is certainly an issue, these broad-based investments are generally considered less volatile than other investment vehicles. To be clear, some mutual funds are also constructed to diversify away risk, as they too invest in or mimic broad indexes. However, many mutual funds are also actively managed and often highly concentrated in one particular sector. This can increase investment risk. (For more insight, read Words From The Wise On Active Management.)

Hedge funds are considered among the riskiest investment vehicles because a hedge fund may go long or short and purchase a variety of hybrid investments in an effort to beat the market. In addition, some hedge funds use options or other derivatives to purchase or control large amounts of stocks in the hope of achieving superior returns. This, too, can dramatically increase a fund's risk profile. (To learn more, read Hedge Fund Failures Illuminate Leverage Pitfalls.)

As evidence of just how risky hedge funds can be, one need only look at Amaranth Advisors. In 2006, the fund is said to have leveraged its holdings by as much as 8:1 in order to place a large bet on the direction of futures contracts. The contract price moved against Amaranth and losses are said to have topped $6 billion. Prior to the debacle, the fund's total assets were reportedly just over $9 billion.

Hand Holding
Many money managers and investment advisors will take phone calls and discuss strategy with their investors. However, with ETFs, there is generally no hand-holding. While hedge fund managers may take your phone call, they typically won't discuss their positions or their proprietary trading systems they use. In addition, hedge fund managers assume that their clients, because of the qualifications necessary to open an account, are more sophisticated and generally more risk-averse than a typical retail investor. (For related reading, see Hedge Funds Go Retail.)

Directing Investment Decisions
If you want to have some control over your investments, consider an ETF or invest with an advisory firm. With mutual funds, it is not possible to control the individual stocks or bonds that are actually owned within the portfolio. This may be a problem for environmentally conscious investors or others that want strict control over their holdings.

With that in mind, hedge funds investors have perhaps the least control over their holdings. Hedge fund managers frequently dart in and out of investments, often on short notice, in an effort to beat the market. In addition, hedge fund managers are highly protective of their trading methods and strategies, and for that reason, investors and the public at large are usually only aware that a fund has bought or sold a stock after the transaction has been completed.

Bottom Line
There is no pat answer for what type of investment is better, ETFs, mutual funds, hedge funds or advisory firms. Therefore, investors must weight their options carefully and consider their individual circumstances to choose the most suitable option.

Related Articles
  1. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  3. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  4. Mutual Funds & ETFs

    Top Three Transportation ETFs

    These three transportation funds attract the majority of sector volume.
  5. Professionals

    Tax Efficient Strategies for Mutual Funds

    Before you sell mutual fund shares, consider these tax strategies first.
  6. Professionals

    Fund and ETF Strategies for Volatile Markets

    Looking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
  7. Investing Basics

    Tops Tips for Trading ETFs

    A look at two different trading strategies for ETFs - one for investors and the other for active traders.
  8. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  9. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  10. Investing

    Oil: Why Not to Put Faith in Forecasts

    West Texas Intermediate oil futures have recently made pronounced movements. What do they bode for the world market?
  1. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  2. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  3. Do financial advisors get paid by mutual funds?

    Financial advisors are reimbursed by mutual funds in exchange for the investment and financial advice they provide. A financial ... Read Full Answer >>
  4. Why is fiduciary duty so important?

    Fiduciary duty is one the most important professional obligations. It basically provides a much-needed protection for individuals ... Read Full Answer >>
  5. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  6. Why do financial advisors have a fiduciary responsibility?

    Financial advisors governed by fiduciary duty are bound by law to act in the best interests of their clients at all times. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!