With flat interest rates, a rising cost of living and worries over the long-term stability of pensions, many people are looking for other ways to boost their income and support themselves in later life.
Over the long-term, investing in stocks and shares can be a great way to make your money work harder for you than leaving it in a bank account. But for many interested in investing, it’s difficult to know where to start.
Putting your money into a fund may be a solution. Funds allow you to invest in the stock market whilst leaving the investment decisions to an expert fund manager. They will invest in a portfolio of stocks, bonds or other assets on your behalf. If the assets perform well, the value of your investments will increase over time, meaning you can end up with more than you put in. As with all investments, their value may go down as well as up but for long-term amateur investors, funds may be a great option.
In this article we cover the basics of funds, help identify the right fund type for you and show you how to get started.
What is a fund?
At its most basic level, a fund is a pool of money that has been set aside for a specific purpose. A fund could be used for saving for university, in case of emergency (a rainy day fund) or for a specific person in a trust fund.
In the investing world, a fund is a pool of money from lots of different investors which a fund manager then invests on their behalf. This investment could be in a number of different types of asset, including shares, bonds or property, depending on the investment objective of the fund.
There are also different types of fund that individuals or institutions can invest in. For example, hedge funds will invest the assets of high-net-worth individuals and institutions in a way that is designed to earn above-market returns, whereas Governments may use special revenue funds to pay for specific public expenses.
Funds are popular with investing beginners and experts alike because they take away much of the pressure of choosing and managing your own investments. There is usually a management fee attached, but for many not having this responsibility is worth the cost.
What are the different types of funds?
In terms of investments, some of the more common fund types include:
Mutual Funds:
These are investment funds managed by professional fund managers who allocate the funds received from individual investors into stocks, bonds and/or other assets. There are a number of different types of mutual fund, with 7 of the most common being:
1. Money-market Funds
These funds are highly liquid mutual funds purchased to earn interest for investors through short-term interest-bearing securities such as government bonds, certificates of deposit and commercial paper. They are generally a safer investment but have a lower potential return than other types of mutual fund.
2. Fixed income Funds
These funds buy investments that pay a fixed rate of return. These include government bonds and investment-grade and high-yield corporate bonds. Funds that hold government and investment-grade bonds are generally safer than high-yield corporate bond funds.
3. Equity Funds
By investing in stocks, these funds aim to grow faster than money-market or fixed income funds. As such, they are generally more risky than these other types of funds. There are a variety of different types of equity funds available. Some will specialise in growth vs income, and vice versa (more on this later), value stocks and large, mid and small cap stocks.
4. Fund of Funds
Also known as multi-manager funds, these are funds that invest in other funds. This, therefore, provides an even more diversified package of investments than a normal fund.
5. Specialty Funds
These funds will often have a specialised mandate. In recent years socially responsible investing has become a popular investment for specialised funds. This means a fund may invest in renewable energy, clean water technology or companies that actively promote diversity.
6. Balanced Funds
These funds invest in a mix of equities and fixed income securities, with many following a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds.
7. Index Funds
These funds aim to match the performance of a particular stock market index – like the FTSE 100 – often by simply investing in every share in the index being tracked. Index funds typically have lower fees because the fund manager doesn’t have to do as much research or make as many investment decisions.
Exchange Traded Funds:
ETFs are similar to mutual funds but, like stocks, are traded on the public exchanges. For example, the SPDR S&P 500 ETF (SPY) tracks the S&P 500 Index. ETFs can contain many types of investments, including stocks, commodities, bonds or a mixture of investment types.
Government Bond Funds:
These funds allow investors to put their money into UK government bonds
Hedge Funds:
Hedge funds are investment vehicles for individuals with a high net worth or institutions designed to increase the return on their pooled funds through high-risk strategies. This can include short selling, derivatives and leverage.
Active vs Passive fund management
When choosing a fund type, you may have a choice to go with an active or a passive fund manager. An active fund manager will conduct research and make investment decisions with the aim of beating a set benchmark. This is usually a market index.
A passive fund manager, on the other hand, will buy a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.
Active management funds usually have higher fees as there is more work involved in making the investment decisions. It is also debatable whether or not they are able to successfully outperform the market on a consistent enough basis for these additional fees to be worth it.
Income vs growth
You may also have the option to choose between a fund that provides income (inc) and one that provides accumulation/growth (acc). If you choose Income, this means that any income generated by the fund is distributed back to you, usually in cash. Accumulation, on the other hand, means that any income generated by the fund, including dividend or interest, is automatically reinvested into the fund. Either option may be suitable to you depending on your investment objectives
Getting started with investing in funds
So, you’ve found the fund type that suits your investment aims. How do you get started? Many stock brokers will allow you to open an account and start investing immediately, but there are a few more things you should consider first.
How much should I invest?
There are broadly two ways to invest money – through lump-sums or by drip-feeding into your fund. Due to the volatility of the stock market (especially these days), it is generally considered wiser to drip-feed your money into an investment. As a rule of thumb, you should never invest more than you can afford to lose.
With a fund you should be looking to make regular payments over a long period of time. Many providers will allow you to invest as little as £25 a month, with some allowing even lower. This will be more manageable for your finances and allow you to build up a larger sum over time.
How long should I invest for?
Funds are long-term investments, and as such many financial experts will suggest you invest for at least 5 years. This will allow enough time for your investments to ride out any peaks and troughs that the stock market may go through.
What are the benefits of investing in funds?
There are several potential benefits to investing in funds, with the most obvious being a reduction in the potential level of risk. By diversifying your investments, you lower the chance that one company performing badly or going under will damage your portfolio.
Other benefits include the ease at which you can invest, the option for professional management and the low costs associated, both in management fees and the amount you need to start investing.
What are the risks?
As with all investments, investing in Funds guarantees nothing. Funds face a variety of risks, including country, credit, currency, interest rate, liquidity and market risks. Diversification works to reduce your level of risk, but there are still multiple factors that can impact how much you make.
When it comes to risk, it’s always better to err on the side of caution and speak to a professional financial adviser.
Investing in funds with an ISA
When it comes to buying into funds, you’ve got a couple of options. Most stockbrokers will have a share buying account where you can buy and sell funds with no investment limit. Most providers will have a admin fee and a dealing commission for every deal you make. Any profits you make will also be subject to tax.
An increasingly popular alternative is to invest through a Stocks and Shares ISA. By investing into an ISA, you’re still able to buy and sell funds, shares and bonds but you won’t pay Capital Gains Tax or Further Income Tax to pay on profits. So all the money you make, you get to keep. There is a limit on the amount you can invest (£20,000 in the 2019/2020 tax year) and there are often small admin costs but if your funds are performing well, these will be worth it. Some providers will also have a Ready-made option, where you can invest into a fund of funds that is looked after by a professional fund manager.
Before you invest, it’s important to understand the fund’s investment goals and make sure you are comfortable with the level of risk. Even if two funds are of the same type, their risk and return characteristics may differ. You may also want to seek financial advice from a professional to help you decide which types of funds best suit your investment objectives.
Photo by Markus Spiske on Unsplash
