It can be easy to confuse the differences between mutual funds and listed options in Malaysia. While both have a place in your portfolio, there are important distinctions that you should understand before you invest.
Mutual funds are a popular investment choice in Malaysia, but it is also possible to make money from listed options on the stock exchange. While these may seem like very different financial products, they each have pros and cons for investors, depending on what kind of trade they want to conduct.
This article will explore some of those differences and highlight why one option may be better suited than the other for certain sorts of trades.
What is a mutual fund?
Mutual funds pool investor contributions into large portfolios, which are then invested in a range of different assets. The average mutual fund may hold thousands of different securities, including stocks, bonds and even some forms of derivatives (contracts that derive their value from underlying assets).
Typically, the pool of investors takes on all of the portfolio’s market risk, while an investment manager uses their expertise to beat the benchmark for that type of asset class. It’s often easier said than done, especially when you factor in fees and taxes.
As with other pooled investments, mutual funds allow investors with limited capital to diversify at relatively low costs across many companies. There are no set up costs, and most funds levy annual management fees around 1% – 2%. In return, you get exposure to a broad range of stocks and the opportunity for your money to grow over time.
What is a listed option?
As with mutual funds, listed options are a tradable financial instrument. However, unlike mutual funds, they derive their value from underlying securities such as shares in public companies.
They can be used in two primary ways:
To hedge existing positions – when an investor wants to reduce market risk by reducing exposure to share price fluctuations To profit from falling or rising markets – by ‘selling short’ when prices are expected to fall, or buying call options instead of individual shares if they believe prices will rise.
The option owner has the right but not obligation to buy/sell a certain number of shares at a predetermined price on or before a specific date.
When you buy an option, your maximum risk is the amount you pay for it, but your potential return is theoretically unlimited. When you sell options, your potential returns are capped at the premium received upfront, while your losses can be almost unlimited if the trade goes against you.
What are some of their similarities?
There are three broad areas where mutual funds and listed options have common ground. The first is that they’re both simple to understand and easy to use. They also give retail investors access to professional investment strategies that would be otherwise only accessible to high net worth individuals or large institutions which manage money internally. Finally, they provide liquidity because they can be bought and sold quickly and easily.
What are the main differences?
When we take a closer look at mutual funds and listed options, it becomes clear that they’re not necessarily all that different after all. Both offer an easy way to invest in either short or long term, buy or sell stock (or other assets) without having to purchase them outright.
However, when it comes to specific advantages, there are some significant differences to consider:
Taxation
When you sell a listed option, any gains are usually treated as capital gains, meaning you don’t have to pay taxes until the following year. With mutual funds, you pay tax annually based on your marginal income tax rate for that year.
Price transparency
You can see what listed options are worth at any time because they have a transparent market value. The price of listed option contracts changes all day, while mutual funds don’t fluctuate in the price unless someone decides to buy or sell them.
On the other hand, just like shares in public companies, it’s also possible for listed options to become worthless if no one wants to buy them anymore.
Read more about mutual funds here.
