When it comes to investing, the jargon can often be paralysing. This is incredibly unfortunate because inaction is often the worst option.

This article cuts through the noise to make the differences between your investing options plain and simple, so you can make a decision and move forward with your focus firmly centred on what’s most important - accumulating wealth by investing!

Let’s begin.

What is CHESS-sponsored investing?

Put simply, CHESS-sponsored investing is when you buy, sell and hold your shares directly with the Australian sharemarket, also known as the Australian Securities Exchange (ASX).

When you buy shares through a CHESS-sponsored broker, the ASX puts your name, address, and other personal details in the “Owner” column.

For completeness, CHESS stands for Clearing House Electronic Subregister System. It’s the (unintuitive) acronym used to describe the underlying computer system used by the ASX to record shareholdings and manage the settlement of share transactions.

What is custodial investing?

Put simply, custodial investing is when you buy, sell, and hold shares via a third party - known as the custodian.

When you purchase shares via a custodian broker, the ASX puts the custodian’s name and address in the “Owner” column. The custodian then assigns a beneficial interest in the shares to you, their customer. This means you don’t directly own the shares you invest in, but rather the custodian owns the shares on your behalf.

What is micro-investing?

Micro investing is different from CHESS-sponsored and custodian investing in that you don’t buy, sell and hold shares. Instead, you’re buying, selling, and holding units in managed funds. Each managed fund then pools customers’ monies together and then invests it on their behalf, according to specified rules. When you invest in a managed fund, you get units in the fund, with each unit representing an equal portion of the fund’s value.

Micro-investing apps typically offer multiple managed funds as “investment options” on their app. From an investor’s perspective, these investment options are similar to custodial-held investments in that a third party has direct ownership of the shares. However, where they differ is that the shares aren’t assigned to you immediately when you invest money. Rather, the micro-investing app will wait until the end of each business day (typically) to invest all pooled monies that have been deposited that day.

What are the pros and cons of each option?

Despite what some companies will try and make you believe, there is not a “one size fits all” option here. Depending on your circumstances and your investment goals, the best way to invest changes. In fact, you may find that a mix of approaches is the best way to satisfy your investing needs!

Advantages of CHESS-Sponsored Investing

• Direct & secure ownership – With the CHESS system you are registered with the ASX as the legal owner of the shares via your Holder Identification Number (HIN). Your broker operates as the facilitator between you and the exchange. This means that on the off chance your broker goes under, you won't be impacted, as your shares are registered with the exchange, not the broker.

Important note: there are several examples of Australian custodian brokers failing and losing some of their investors’ money. Halifax in 2019 (Shares, CFDs – approx $33m loss), BBY Stockbroker in 2015 (Shares, Derivatives, CFDs – approx $40m loss), Sonray in 2011 (Shares, CFDs – $47m loss). This is often touted as the main reason why most Australians with medium-to-large investment portfolios choose to invest with CHESS-Sponsored brokers.

Since micro-investing apps have a similar underlying structure to custodian brokers (both are “custodians”) the same underlying risk exists. However, since micro-investing accounts typically have significantly lower balances, this risk is materially reduced.

• Voting rights – As a direct shareholder in a company, you have the right to vote at general meetings and make decisions on directors, remuneration, and other company business - which is pretty cool!

Typically neither custodian brokers nor micro investing apps pass voting rights onto shareholders.

• Simplified portability – If you decide to switch brokers to take advantage of a better price, improved user experience, or a more diverse product range, you can easily move shares between CHESS-sponsored brokers. Typically you just need to complete a 2-page online form and your shares will be transferred to your new broker within a week.

For custodian brokers, this process typically involves more paperwork and longer timeframes. It also typically is seen as a tax event by the tax office as the official owner of the shares changes from your old custodian to the new one (even though you are the beneficial owner before and after). These tax consequences can be significant, so it’s worth talking to an accountant if you’re considering transferring a significant parcel of shares from one custodian broker to another.

For micro-investing apps, share transfers typically aren’t offered. As such, the only way to transfer your investment from one app to another is to sell your holdings, withdraw your investment balance, and then invest it in your new app.

Advantages of Custodial Investing

• Access to international markets – the CHESS system is specific to Australia, and in most of the world’s largest share markets (e.g. the USA), there is no equivalent. This means if you want to buy, sell, and hold specific international shares you will most likely need to open a custodial account.

One of the great things about custodial accounts is that you typically don’t need to open a new account for every market you wish to invest in - i.e. one account can give you access to multiple international markets.

Alternatively, if you just want to get international investment exposure but don’t want to invest in a specific international company, you can always invest in international exchange-traded funds (ETFs) via a CHESS-sponsored account.

Similarly, most micro-investing apps have international fund investment options too.

Side note: You might be wondering - why is there no CHESS equivalent in many overseas markets. The main reason seems to be age. Newer markets such as Australia and New Zealand have direct ownership options, but most older (and larger) markets don’t. Technical debt is one explanation for this - the more established the market the harder it is to change its existing systems, even if better ones exist.

• Fractional shares – You can often buy and sell shares in fractions, rather than whole shares with custodian brokerage accounts.

This is particularly useful for international share markets such as the USA where a share in an individual company can often cost over $1,000. At the time of writing, Amazon, Tesla, and Google all have share prices in the thousands of dollars.

Micro investing apps support this too, but only for the shares within the managed funds they offer (so limited customisability).

CHESS-sponsored investing does not support this; you have to own whole units.

• Cheaper brokerage – Since custodian brokers are the official owners of shares, they are able to do complicated things in the background that reduce their costs and/or increase revenue. Therefore, custodian brokers are typically able to offer lower brokerage fees to their end users than their CHESS-sponsored counterparts.

Similarly, micro-investing apps are able to offer competitive prices - they are typically even cheaper for small investment amounts - see below.

• Less paperwork – Since the custodian is the official owner of the shares, they are able to streamline all administration on your behalf. This means that custodians typically organise dividend and interest payment collection and distribution for you, as well as lodge your tax information. Similarly, micro-investments typically offer streamlined investment administration as well.

You aren’t able to do this with CHESS-sponsored investments because you are the official owner of your shares. Therefore, you must update your details with the ASX directly using the share registries.

Advantages of Micro Investing

• Low minimums – As micro-investing platforms are able to pool investors’ monies together, they are able to offer extremely low minimum investment amounts.

You can get started investing on some micro-investing apps with as little as $1, and additional investments can be even less!

This is typically not offered with CHESS-sponsored or custodial investing, as they don’t pool investors’ monies and therefore it becomes prohibitively expensive to manage small investments. At least $100 is typically required for every new CHESS-sponsored or custodial investment.

• Round ups – Some micro-investing apps enable you to automatically invest every time you make a transaction, with a common option being “rounding up” purchases to the nearest dollar and investing the difference.

This option is not offered with CHESS-sponsored or custodial investing as their minimum investment amounts are typically +$100.

• Cheaper for small investments – Even for investments of $100 to $1,000, micro-investing is typically cheaper than CHESS-sponsored or custodial investing.

Micro investing apps typically charge a flat monthly fee that’s less than $5 per month plus a very small percentage of the investment balance, whereas CHESS-sponsored and custodian brokerage platforms typically charge $5 to $20 every time you buy or sell.

This means that it’s typically much cheaper for you to accumulate $5,000 by investing $100 every 2 weeks in a micro-investing app than a brokerage platform.

Note: one key disadvantage of micro-investing that hasn’t been emphasised yet (and should be) is that you are limited to the set of investment options that the app provides. You aren’t able to pick any share from the sharemarket to invest in; your choice needs to be one of the handful of options that are offered by the micro-investing platform.

When is the perfect time to use each option?

At this point it’s appropriate to re-emphasise that the difference between investing via a CHESS-sponsored, custodial or managed fund (micro) structure is going to be negligible when compared to not making any investments over the long term.

All of these options are likely to be substantially better than having thousands of dollars sit in a bank savings account or term deposit for decades if your goal is to accumulate wealth.

That said, each of the options is better suited to some circumstances than others. To give some colour to this, we’ve outlined a perfect scenario for using each of these investment structures below.

CHESS-Sponsored Investing | Perfect Scenario

Your investing goal is Financial Independence. As such, you’ve decided to allocate 10% of your monthly income to investing. You want to maximise the security of your investments, so have decided you are willing to pay a slight brokerage premium for CHESS-sponsored shares. You want to maximise the diversification of your portfolio and want to minimise the time you spend researching shares and on portfolio administration so you’ve decided to invest in a single ASX-listed diversified exchange-traded fund (ETF) such as ASX: VDHG or ASX: DHHF to achieve your financial independence goal.

In these circumstances, CHESS-sponsored investing is perfect.

Custodial Investing | Perfect Scenario

Your investing goal is to “Beat the Market” by researching undervalued shares across the globe and investing in them for the long term. As such, you need to access global markets. For instance, perhaps you’ve identified that Tesla is undervalued (note: this is a random example!).

You open a custodial account to make your investment (because that is the only option for US shares), and away you go.

PS: It’s prudent for us to point out that hardly anyone (even professional investors) can consistently beat the market. If this is your main investing goal, we highly recommend you read this article: How to simplifi your investment strategy.

Micro Investing | Perfect Scenario

Your investing goal is an Overseas Holiday, and you want to save for it faster than you would by just using a savings account by investing $10 per week. You also want to round up transactions and invest them for a bit of extra spending money

You'd also like to minimise fees paid, while still investing regularly and accumulating a few thousand dollars. In this case, micro-investing is the ideal solution.

Invest however is best with Pearler

What if you want to securely invest to achieve Financial Independence with most of your money, but also make a small investment or two overseas companies you really love? And, at the same time, you'd like to accelerate your savings for that overseas holiday?

No need to open 3 different accounts to get it all done. With Pearler, you can invest in CHESS-sponsored ASX shares, invest in US shares (under a custodial structure), and micro-invest in up to 8 different managed fund options, all on one platform.

Best of all, you can automate it all so you can set-and-forget, and sit back and watch your goals become reality. Check our Pearler's range of investment options.