by Jack Scott, Founder of Investeo
We’ve long championed the idea that investing is for everyone, I’d argue that its becoming a qualified necessity rather than a luxury. Investing takes many guises and there are so many different products and assets you can invest into. We generally think of stocks and shares when we talk about investing and this is because it’s a very convenient and accessible way to purchase assets and begin building your investment portfolio. You do however need to create a portfolio of investments that suits your appetite for risk, is well diversified and rebalanced from time to time. You might also want your investments to match your social and ethical principles. All of this can seem pretty overwhelming but a quick way to manage all of this in one purchase is by investing in Funds. What exactly is an investment fund though?
I’m delighted to be able to introduce Jack Scott, Founder of Investeo who has authored this article for us which will tell you everything you need to know about investment funds.
Niaz Azad, Co-founder of Millennial Money UK
If you’ve spent any time looking at investments, then it’s likely you’ll have come across investment funds. This isn’t hugely surprising given that UK investors have around £1.15 trillion invested in investment funds. Despite this, investment funds (and the jargon surrounding them) can seem confusing for those just starting their investment journey.
Unlike investing in individual companies (e.g. buying Apple’s shares), funds allow you to buy a diversified basket of investments in one simple transaction. The performance of a fund depends upon the value of the investments held within it. If the value of these investments go up on any given day, the value of the fund will generally go up (and vice versa).
“Investing in a fund means you’re buying a mix of investments in one convenient transaction.”
Funds give investors four major benefits:
Purchasing a fund allows you to automatically diversify your investment and spread the risk across a basket full of investments. This is why purchasing shares in an individual company is much riskier - to extend the analogy, you are putting all of your eggs in one basket. See below for a comparison between an equity fund and an individual share:
Have you ever wondered if it was possible to easily invest in all the big tech companies like Facebook, Amazon, Google, Twitter and Netflix? Or maybe you don’t want to invest in harmful industries like oil & gas or tobacco? The good news is that funds come in all shapes and sizes, meaning that you’ll be able to find one that aligns with your values, preferences and risk appetite.
Below are some of the main filters you could choose when selecting funds:
The next topic to cover when it comes to investment funds is the management style of the funds. There are two styles you can choose from: ‘actively’ managed funds or ‘passively’ managed funds (also known as ‘tracker’ or ‘index’ funds). The below table describes the main differences.
The higher costs of active funds have led to many experts who believe that passive funds provide the best value for most investors over the long term.
The third concept is fund types. If there’s one topic that highlights how the finance industry tries to make things confusing, it’s fund types. Financial advisers and investment platforms are really good at throwing around complicated terminology when it comes to fund types. Some examples include exchange traded funds, mutual funds, open-ended funds, closed-ended funds, unit trusts, investment trusts, or sometimes just ‘funds’. Confusing to say the least…
We’ve sifted through all the jargon to make this simple. You essentially have two choices when it comes to choosing a fund type, which we like to classify as ‘Exchange Traded Funds’ or ‘Open-ended Funds’. The right choice for you depends on your circumstances.
There’s also a type of fund called an Investment Trust (also known as closed-end funds). These are not common investments for a beginner or intermediate investor, so we’re not going to spend time talking about them here.
The final concept covers fund units. If you’re familiar with different asset classes then you’ll know that certain assets provide investors with regular income (e.g. shareholders often receive dividends). For some investors, receiving regular cash payments (i.e. regular income) in the form of dividends suits their needs.
For example, if you’re retired then having a regular stream of dividends can replicate receiving a pay cheque. For investors who don’t need a regular stream of income then it may make more sense to reinvest these dividends back into the original investment – this is known as ‘accumulating’ your investment.
In investment speak, a fund’s ‘unit’ determines how any income generated from the fund's underlying investments is treated. In other words, is it paid out to you as income or is it reinvested?
The decision whether to buy income or accumulation units will depend on your goals. Do you need the income now, or do you want to wait, giving your investment a chance to grow over the long term?
Income units are often used by retirees to bolster their pension payments, but if you don’t need the cash now, accumulation units offer the benefit of compound growth.
Once you’ve decided on a fund strategy, management style, type and unit, you’ll be in a good position to search for suitable funds. You can do this through your chosen investment platform (there are many different providers out there). Most investment platforms will allow you to filter funds in a way that suits your preferences (just like clothes shopping online!).
The last step is to watch the small print. All Investment platforms are under pressure to be transparent with fund documentation and fees. We’d encourage you to take a look at the following information when analysing a fund:
The fees (i.e. ongoing charge) of the fund
The past performance of the fund and track record of the fund manager
The fund investment strategy
The fund inception date
You’ll find a lot of this information in a fund’s ‘Key Investor Information Document’ and ‘Prospectus’, which every investment platform will make available.
Whether you’re a beginner or a seasoned investor, investment funds can, and should, play an important role in your investment journey. With a little bit of planning and research, investment funds will provide you with more choice, lower fees, lower risks, and less hassle. Who wouldn’t want that?
Investeo’s mission is to empower young adults to feel good about their finances and their futures. We’re levelling the financial playing field with our jargon-free personal finance guide and inclusive social community. It’s personal finance, simplified.
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