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Investment funds

Investment Funds: What you Need to Know

Key points

  • Investment funds pool money from multiple investors to buy assets.
  • Funds offer a passive and active option to cater to different goals.
  • Investment funds offer a straightforward way to build a diverse portfolio.

Investing in the stock market can be daunting, especially for new investors.

Analysing complex charts, picking the right investments, and monitoring their performance are enough to make you wonder if investing is for you.

Thankfully, there is another way. Investment funds are financial products that do the heavy lifting for you. And with around $61 trillion invested in funds globally, they are a popular option for new and experienced investors.

So, what are investment funds, and how do they work? Here is what you need to know.

What are investment funds?

Investment funds are also known as collective investment schemes (CIS).

They are financial products that pool money from multiple investors into one pot. This pot is then used to buy in a wide array of underlying investments.

Funds invest in multiple companies, which means they can offer a more accessible way to invest in a broad range of assets. Because the money is pooled, investing in a fund often costs much less than investing in individual shares or assets.

While funds typically consist of one asset type, such as shares (equities) or securities (bonds), some contain a mixture of different asset classes.

How do investment funds work?

An investment fund is a ready-made basket of different investments. The fund manager will use the pooled resources to buy assets on behalf of the investor.

Investors do not manage the underlying investments themselves. They simply choose a fund based on factors such as financial goals, costs, and risk level.

Instead, a fund is managed in one of two ways—passively or actively. The main difference between the two is their intended purpose.

A passive fund is set up to track a specific index, such as the FTSE 100 or S&P 500. This means it performs in line with the index it tracks. However, an active fund seeks to outperform the index. To do this, a fund manager actively manages it.

When setting up the fund, investors typically choose either the income or accumulation version of the fund.

With an income unit, any return on investment (ROI) is paid directly to the investor. Meanwhile, with an accumulation unit, interest earned or dividend income is put back into the fund.

Both options have pros and cons, but accumulation units may better suit long-term investment goals due to compound interest. Read our blog to learn about the power of compound interest.

The different types of funds

There are a plethora of options for investors who wish to invest their money in a fund. Here is a breakdown of some of the main options:

Mutual funds

Mutual funds are the oldest type of fund, having been around since the early 1920s. They use pooled resources from investors to buy a mix of shares. These shares are priced and sold daily, specifically at the end of each trading day.

Exchange-traded funds (ETFs)

Exchange-traded funds, or ETFs, are similar to mutual funds but offer a little more flexibility. However, unlike mutual funds, ETFs are traded on exchanges. Like stocks, they can be bought throughout the day.

Hedge funds

These are actively managed funds with one aim—to maximise investors’ returns. Hedge funds are a high-risk, high-reward option typically open only to accredited investors.

Index funds

Index funds are also known as tracker funds. They are set up to track a specific market index, such as the FTSE 100, NASDAQ, or S&P 500. Their aim is to match the index’s performance, not beat it.

Real estate investment trusts (REITs)

Real estate investment trusts, or REITs, represent a unique option for investors. They allow you to reap the rewards of property investments without the need to purchase real estate.

Like other funds, REITs pool money from multiple investors to purchase a basket of underlying property investments. REITs are traded, just like stocks. This makes them far more liquid than real estate options.

Pros and cons of investment funds

Like any type of financial instrument, investment funds have pros and cons. Let’s start by looking at the pros.

Pros

  • Diversification made easy: Funds spread the overall portfolio risk by investing in a wide variety of assets.
  • Professionally managed: Investors benefit from the expertise of professional fund managers.
  • Liquidity: Funds typically offer high liquidity, meaning investors can quickly sell their shares and turn them into cash.
  • Market access: Some markets can be tough to access.

Cons

  • Cost: Investment funds are generally cheaper than buying and selling individual assets. However, platform fees still apply. If you choose an active fund, costs are even higher and can eat into your returns.
  • Control: Funds take a lot of the heavy lifting out of investing. Instead, the fund manager allocates where money is invested. For some, having less control may be a drawback.
  • Market risk: All investments carry some level of risk, and funds are no different. Be aware that while the value of your investments can increase, they can also decrease based on market conditions.

To fund or not to fund?

Investment funds offer a convenient and effective way to invest in the stock market. In terms of options, investors are spoilt for choice.

However, with so many options, knowing the pros and cons of each type of fund and its associated costs is essential. The fund you pick must align with several factors, such as your short-term and long-term goals and attitude towards risk.

Not sure what the best investment strategy is to reach your financial goals?

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