Funds are pooled investment vehicles that have a number of different investors combining their resources to buy a wide array of investments. The advantage of this is that investors have the financial muscle to make a big impact in the market. while being able to spread the risk across a wide variety of investments.
The downside is that, as an individual investor within the fund, you don't have the rights to decide what investments to make, or how those companies you are investing in behave – it's down to the fund managers.
While the majority of funds are based on stocks, many take on a number of different investments to both maximise possible returns and to reduce the risk. So a fund may be made up of a basket of shares, but also have components relating to foreign exchange, derivatives or bonds. It all goes together to create the return.
Most funds, but not all, expect either a significant lump sum investment, or a commitment to pay in a certain amount each month. There's normally a period before which you can take out your money as well, although as investing on the markets should be considered a long-term plan, you shouldn't really need to take out any money too soon.
The funds will charge a commission for their services, which pays for the fund manager and the associated administrative costs. This is normally set as a percentage of the fund's value on a given date and is normally a couple of per cent.
There are a number of different options to choose from when picking a fund – here are some of the most common:
Tracker fund
These funds are the most straightforward and normally the cheapest in terms of management fees. They track a specific index and have a balanced number of stocks within that index. So a fund that tracked the FTSE100 largest companies would only have shares within it from those companies. It would be weighted so that the fund matched exactly what the FTSE100 companies did.
This makes it easy to follow in terms of growth – most news programmes will tell you every day whether the FTSE is up or down, and you can tell how your investment is doing accordingly.
Because no investment expertise is required for these funds, fees are generally lower.
ETFs
Exchange traded funds are bought and sold just like shares – you don't need to commit a large lump sum, or a regular monthly payment, and you can take your money out at any time. The value of each share in the fund depends on the value of the stocks within it at any time – so if the stocks it holds have risen by five per cent on average, then the cost of a share in the fund is going to go up by the same amount.
You buy and sell your shares in an ETF in just the same way as you would if you were buying or selling shares. Most funds have a set number of shares, again just like a listed company. But some are open-ended, which means that the number of shares available depends on the number of people who want to buy them. The more shares sold in the fund, the greater its buying power.
Sector-specific
These funds track a particular industry or segment and focus all their investments on companies within that industry. So a property fund would look at house builders and – possibly – mortgage lenders, while a minerals would invest in oil and gas and mining companies.
These are slightly higher risk than those that look at the whole of the market as if one industry started to suffer, then it's likely all the companies within that industry would feel the heat. This has happened, with new media stocks falling at the turn of the millennium and property companies suffering now.
Ethical
Ethical funds are becoming increasingly popular. The definition of ethical varies, but broadly it means the fund won't invest in companies that produce weapons, tobacco or pornography, but it can mean anything – it depends on the fund.
Other funds consider themselves positive ethical, which means they search out firms that are helping improve the world – inventing green technologies, for example. Because these funds can be investing in very new companies, their risk profile may be higher.
Advice
As with all investments, it's important to get the right advice. A good financial adviser will be able to tell you about the risk profile of different funds, whether you can invest in them within an ISA, and about the costs associated with them. Use our IFA index to find one close to you.
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