While a great range of opportunities for investment exists right now; exchange-traded funds (ETFs) and limited liability companies (LICs) are two of the most widely used. 

However, what really differentiates them? 

I’ll compare and contrast, examining their features and weighing their relative merits. In the end, you’ll know what’s the difference better after reading this ETFs vs LICs guide…

Table of Contents:

• 📚📘 What are ETFs
• 📚📕 What are LICs
• 🏛️ What ETFs have
• 🏛️ What LICs have
• ⚡ Key things to look out for in ETFs
• 📖 What’s the difference
• ✔️ ETFs vs LICs advantages 
• 🦅 ETFs vs LICs legal structure
• 🌞 Bottom Line
• FAQs

ETFs vs LICs 💨: What are ETFs? 📚📘

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Exchange-traded funds are sort of like a managed fund that trades on the stock market, much like common stocks.

Exchange-traded funds are a sort of index fund that mimics the behaviour of a market index. Many ETFs track the ASX 200 index, the S&P 500 Index, and so on. These ‘passive’ ETFs don’t actively seek to beat the index but rather they replicate its performance as nearly as possible, although with lower costs.

These mutual funds are exchanged much like stocks on a stock exchange. A basket of assets is “wrapped” in an exchange-traded fund. While equities (stocks) are the most common underlying asset for ETFs, other asset types may also be encapsulated, including infrastructure, commodities, bonds, and cash.

The ability to invest in a wide variety of assets at a cheap cost is a major perk of ETFs. Popular index funds work similarly. For example, the Betashares A200 ETF is a top-performing exchange-traded fund in Australia which provides investors with access to all 200 businesses listed on the ASX with a single purchase and a negligible management charge.

• Related guide: ⭐ Stock market basics.

ETFs vs LICs 💨: And what are LICs? 📚📕

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‘LICs’ are listed investment companies that, like an ETF, trade on an exchange but are designed differently, giving investors access to a diversified portfolio. Unlike an ETF, the goal of a LIC’s investment managers is to outperform the market.

LIC is a publicly traded corporation, much like any other company listed on an exchange (hence the name, listed investment company). The LIC can invest in a wide range of assets such as stocks, real estate, and bonds. 

When you purchase shares of a LIC, you are investing in a stake in that business. Shares in a LIC may be purchased and sold on the ASX in the same way as shares in any other public business. 

LICs are relatively liquid investments that are comparable to managed funds. However, they have the extra advantage of being listed on the Australian Stock Exchange (meaning you can sell your shares at any time).

They let investors get exposure to markets or assets that would be prohibitively costly or impossible to acquire on their own. Investing in foreign equities, for instance, may be done via a LIC that targets foreign corporations.

The Australian Foundation Investment Company is a famous LIC, created in 1936 and is one of the oldest and largest in Australia. The AFIC fund invests in a wide variety of foreign and domestic securities, providing investors with exposure to markets across the world. However, the AFIC invests less than 1% of its total assets in foreign markets. 

What ETFs have ☁️⛰️

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Hundreds, if not thousands, of individual firms may be “wrapped” up in a single ETF. Companies included in a wrapper may be hand-picked by a portfolio manager or, more typically, chosen at random from a predetermined index. While at first glance two ETFs seem to be identical, there are typically significant variances between them.

Vanguard’s VSO is one well-known exchange-traded fund that invests in firms listed on the Australian Stock Exchange. In contrast to VSO, which participates in the smaller-cap portion of the Aussie market, STW primarily invests in the ASX200, which consists of the 200 biggest businesses on the Australian stock market. 

When a firm is removed from the ASX200 or the MSCI Australia Small Cap Index, the corresponding position is created in the respective ETF to reflect the changed composition of the index.

Fun Fact 💡: Despite popular belief, index funds were not created by The Vanguard Group’s John Bogle. The concept was first proposed in a paper by financial experts Edward Renshaw and Paul Feldstein titled “The Case for an Unmanaged Investment Company.” (Source). 

What LICs offer 🔥🐉

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The investments in a LIC are often actively managed, meaning they are chosen by a fund manager (such as equities or fixed income). With active fund managers, the user experience was bad before LICs were introduced, because of the need for extensive paperwork, high minimum investments, and lengthy processing times. 

However, LICs lack the openness of an ETF. Given that LIC issuers are not obligated to publicly disclose their holdings on a daily basis, it is unlikely that you will be familiar with all the firms comprising the underlying portfolio.

• Learn more 📚: What is a Financial Plan?

ETFs vs LICs 💨 Key things to look out for in ETFs

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Track-record. Although there is no guarantee of future results and growing your savings, you may have noticed that the top-performing exchange-traded funds are often leveraged. Also, bear in mind that leveraged ETFs tend to be among the poorest performers. This is for the simple reason that leverage multiplies both gains and losses.

The possibility of increasing your profits via the use of leverage might seem thrilling, but it also comes with a larger degree of danger. Investing in a single leveraged ETF may be like putting all your eggs in one basket, and it can also be like borrowing other people’s eggs and putting them in the same basket.

Liquidity. An ETFs’ ‘open-ended’ nature is one of its many advantages. For the ETF to have a value that is relatively stable relative to its net asset value, it must be able to be purchased and sold on demand, a feature that helps to reduce “tracking error” (Net asset value, or NAV). To meet this need, the ETF issues new shares or cancels existing ones as the situation warrants. Find ETFs with significant trading volume if you want to build your own diversified portfolio.

Added costs. The MER is the standard term for an exchange-traded fund’s management charge. One of the main advantages of ETFs is the minimal fees they often have. A $1000 investment in State Street’s STW ETF, for instance, would provide you exposure to 200 of Australia’s top firms for a management cost of only $1.30 per year (or 0.13%).

ETFs vs LICs 💨 What’s the key difference?

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They are fundamental dissimilarity in structure. LICs have a fixed number of shares issued, ETFs do not, hence there is no limit to how many investors may buy. As a result, the LICs stock market price may vary widely from its NAV.

If there are a large number of purchasers pushing the price of a LIC over its NAV, the LIC’s set amount of capital may be advantageous. However, this is not the norm. Many LICs trade below their NAV after becoming public. Meanwhile, the NAV of an ETF is more likely to be closely followed by its price.

Choosing between exchange-traded funds and listed investment companies requires careful consideration of a number of factors:

Structure. If you invest in a LIC, rather than owning the underlying assets, you will own shares in the LIC itself, which is a corporation. Given that an ETF is a trust, investors in such a vehicle will be issued units in the underlying fund. For a LIC, like any other corporation, the board of directors decides each fiscal year whether or not to provide dividends to shareholders. However, any dividends received by an ETF must be distributed to shareholders.

Effects on your taxes. In the event that the LIC gets unfranked dividends from the underlying assets, it will pay tax on those dividends at the company tax rate and then distribute franked dividends to shareholders. When it comes to taxes, an ETF uses the Attribution Managed Investment Trust (AMIT) structure, which means that all dividends are distributed to unitholders. Additionally, the AMIT rules apply to ETFs.

Open versus closed. Because of the open-ended nature of ETFs, the management may always create additional units (shares) to accommodate new investors. LICs, on the other hand, are closed-ended and have a fixed number of shares on issue in the market, therefore their share price will fluctuate based on investor demand for the LIC rather than the value of the underlying assets.

Management. The goal of a LIC’s investment managers is to outperform the market, allow it may actuallu not achieve this, whereas ETFs are ‘passive’ investments that merely replicate the performance of an entire index.

Cost. Investment managers of LICs make active decisions about which assets to purchase and which investment possibilities to pursue, hence LICs often come with a higher price tag.

Exposure. An exchange-traded fund that tracks a broad index provides exposure to a larger group of assets, perhaps hundreds of equities. Because LICs carefully choose each investment, they typically provide access to just a few hundred underlying assets.

There are many advantages of investing in ETFs, LICs, or even both. Understanding the main differences will help you make a better investment decision:

ETFs vs LICs ✔️ Advantages

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• Low cost. While ETFs are usually cheaper, both LICs and ETFs are very low-cost ways to invest in a pool of assets… For instance, looking at Australian equities for example, the BetaShares A200 ETF has management fees of just 0.07% p.a, and the popular LIC AFIC has management fees of 0.14% p.a. Fees vary depending on whether the fund is passive or actively managed. 
• Diversification. For the one brokerage fee, you get exposure to hundreds of assets. Both investments offer instant diversification across those assets in one transaction. This not only helps to dramatically reduce risk but also investment costs.
• High liquidity. Because they’re traded on a public exchange like regular shares, a lot of ETFs and LICs enable you to easily sell your position, with strong liquidity, if you need the cash or want to invest elsewhere.

ETFs vs LICs 🏛️ Legal structure (Different taxes)

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ETFs. Because an ETF is a trust, its financing comes from a dynamic pool of money that may grow or shrink on a daily basis, based on the number of units bought or sold. This also implies that investors in the fund will be responsible for paying taxes on the fund’s profits at their own individual marginal tax rates, rather than the fund itself.

LICs. However, a LIC is a closed-ended investment vehicle, since it is a listed investment company with money acquired during a capital-raising drive. Managers of LICs have the option of paying out a portion of their company’s income in the form of dividends, which is subject to corporate tax rates.

ETFs vs LICs. Many traders and investors use ETFs and LICs because they provide diversification at cheap costs and are simple to trade with a stock trading account. If you were to buy each of the 200 shares that make up the ASX200 separately, it would probably cost you more than the ETF does in trading and brokerage costs. 

Online brokerage accounts let investors trade ETFs and LICs whenever the market is open. Buying and selling units in online managed funds seem simple today — in comparison to completing application and redemption procedures and identification checks on every new fund purchase the old way. 

ETFs vs LICs ☴ Bottom Line

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What’s preferable, then? It is not always easy to generalise the quality of ETFs and LICs, just as it is not always easy to with the quality of stock market shares.

Whether you’re looking at stocks, ETFs, or LICs, you’ll find that some are better than others, and others may even be outright bad bets for you — be aware of the following distinctions between the two. Here are some things to think about:

• ☴  Compared to other investment vehicles, ETFs often have fewer expenses. Because excessive fees may reduce the impact of compound returns, they are one of the most crucial factors that investors can influence. An investment in a LIC often entails more costs than an investment in an exchange-traded fund.
• ☴  Mutual funds may hide their holdings and investments from investors, whereas ETFs are more open about their holdings.
• ☴  Fund managers that “go the extra mile” to maximise returns often provide LICs. Exchange-traded funds are passively managed (or use Robo-Advisors) and often cannot hope to outperform the underlying index… ETFs mimic the performance of an index, whereas LICs may either mimic the index’s performance or are actively managed, with the management picking which companies to buy.
• ☴  However, ETFs provide a diversified investment option for investors across a wide variety of asset classes. LICs tend to invest in fewer assets overall, which might increase their overall risk.

Despite the fact that financial jargon may be daunting, the above should make it easier to compare the MER and NAV of an ETF to those of a LIC. Get set up with an 🖱️ Safe Online Trading App.

ETFs vs LICs 📙 FAQs

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What are the management costs for LICs vs ETFs? 

Compared to exchange-traded funds (ETFs), Investors in LICs often can expect higher management costs. That’s because LICs need more attention than passive index trackers like ETFs.

The management charge for AFIC is 0.14% ($14 for every $10,000 invested) whereas the management fee for A200 is 0.07% ($7 per $10,000 invested), to give you a sense of the cost differences between these two investments. 

This may not seem like much, but when compounded over several years, it may amount to quite a few additional glasses of beer!

LICs vs ETFs: do LICs & ETFs provide a dividend?

Note that although some ETFs and LICs do provide dividends, others do not. 

When an ETF pays out dividends to its shareholders, the dividend payment is technically known as a Distribution since the ETF provider is “distributing” the dividend payment it received from the various firms in the portfolio. 

In the case of exchange-traded funds (learn how ETF dividends work…), distributions may be absent if the underlying companies do not pay dividends.

This is especially common for ETFs with a high concentration of investments in foreign markets, where many firms prefer to reinvest their earnings in order to fuel further growth, rather than distribute the proceeds to their shareholders.

LICs might choose to skip dividends and retain the money in the fund because of the way they are structured.  

How large are the LICs vs ETFs markets?

The pace of growth of ETF assets under management (AUM) has been nearly four times that of LIC AUM since the first Australian ETF was introduced in 2001. Meanwhile, the Australian LIC market has shrunk by ten companies since May 2020, when sponsors stopped paying brokers commissions and processing costs.

Can LICs provide advantages over ETFs?

Investors no longer see a compelling argument for LICs against exchange-traded funds (ETFs). Our research shows that exchange-traded funds (ETFs) outperform other investment options in terms of safety, ease of use, cost-effectiveness, tax efficiency, and returns.

Are index funds preferable to LICs?

The dangers are higher with LICs. Many fund managers have failed to generate positive returns for their investors, and these investors would be better off with an Index Fund. It’s possible that the management may start making bad investment choices, or that some of the best players will quit.

What exchange-traded fund does Warren Buffett advocate?

Vanguard S&P 500 ETF (VOO -0.15%) is one of the exchange-traded funds (ETFs) held by Warren Buffett. This mutual fund attempts to replicate the performance of the S&P 500 index by purchasing equities that are included in the index.

What makes ETFs superior vs stocks?

Different from exchange-traded funds, which provide a diversified portfolio of holdings, stocks are ownership stakes in certain firms. Both are purchased by investors at the prevailing market prices, and investors may use order types such as limit orders and stop loss orders to control their exposure.

Would it be wiser to put money into LIC instead?

The death benefits from LIC policies are sufficient to protect your loved ones financially in the event of your untimely passing, but they do not provide sufficient returns for wealth accumulation. As a result, you should seek investments in various financial products.

Is the price of the LIC IPO too high?

Its competitors in the insurance industry, as well as companies like IRCTC, Dixon Tech, and Adani Wilmar, all pale in comparison to its value. It will make LIC’s initial public offering (IPO) the priciest in history.

Why should I avoid investing in LIC IPO?

Due to the high cost of a LIC IPO, the benefits of being listed are not guaranteed. Due to the inflated nature of the LIC IPO, even long-term investors should prepare for the possibility of a price decline by keeping some funds on hand.

Can a novice safely invest in ETFs?

As a result of its numerous advantages, including low-cost ratios, ample liquidity, a wide variety of investment options, diversification, a low investment threshold, and so on, exchange-traded funds (ETFs) are particularly well-suited to novice investors.

Do ETFs pay dividends?

All dividends earned by an ETF on its shareholders’ behalf must be distributed to those shareholders. They might do so either monetarily or by issuing more ETF shares. Therefore, exchange-traded funds provide dividends if and only if the equities they own do so.

Can you live off ETF dividends?

Earnings From Dividends: Sufficient for Subsistence? You can retire on dividends from your assets, but this isn’t always a good plan. It is more important to maximise your portfolio’s overall return than to chase a high dividend yield for the sake of dividends.

Does an ETF provide dividends on a monthly basis?

ETF payouts for dividends. Investors in exchange-traded funds (ETFs) might receive either qualified or non-qualified dividends. Those who invest in exchange-traded funds (ETFs) may be eligible to receive dividend payments. The frequency of these distributions varies from ETF to ETF.

How do I invest in LICs or ETFs?

★ Create a brokerage account. Both ETFs and LICs are stocks that are traded on the Australian Stock Exchange. If you have access to a broker or an online trading platform, such as Pearler or Commsec, you can buy them with a few clicks of your mouse.

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