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A beginner’s guide to investment funds

Not familiar with investment funds? Here’s a short guide to help you understand how funds work.
Fruit and vegetables | Wealthify
Reading time: 8 mins

If you’re about to enter the investment world, it’s important to know where your money will be going. In other words, what will you be investing in?

With plenty of investment types available, building a portfolio can be quite overwhelming, and if you want to make the right decision, it could be wise to familiarise yourself with each asset type.

But whilst it’s quite common to hear people talking about shares and bonds, investment funds aren’t typically talked about quite so much.

So, what are they? And are they right for you? Here’s a short guide to help you understand how they work.

What are investment funds?

Put very simply, investment funds are like 'hampers' full of investments. So, by investing in a single fund, you could well be holding hundreds (or even thousands) of individual investments, which may be a very useful way of diversifying your portfolio.

Diversifying what you invest in (basically, not just investing in one company or type of asset) could help to spread your risk as it means that if one investment drops in value, others may be on the rise.

Investment funds are typically managed by professionals, and these experts are commonly known as ‘fund managers.’ Their job is to manage the fund in line with the fund's objectives – whether that's to replicate the performance of an index like the FTSE 100, or to focus on organisations that are having a positive impact on either society, the environment, or both.

Fun fact: these are actually the types of funds that we use in our customers' Ethical Investment Plans.

In return for this, you'll need to pay an annual fee (called 'a fund charge'), to the fund provider.

What do investment funds look like?

Investment funds come in all shapes and sizes. Some could contain one type of investment from one particular region, whilst others will include a mix of asset types coming from different areas.

For instance, a fund could choose to only invest in the UK’s main stock market, which is the FTSE 100. Meanwhile, another fund could include shares and bonds from different markets.

As an investor, it’s important to look at what’s in the fund you want to invest in – otherwise you might be putting your money in things that don’t necessarily match your investment style.

Most funds are divided into units, and you may be able to buy some of these units. And by purchasing a unit, you’ll own a part of the fund. Depending on what you’ve actually bought, you could be holding a plethora of investments.

And that’s the great thing about investment funds! They could allow you to build a well-balanced and diversified portfolio without the hassle of having to pick each individual investment yourself.

In other words, they can be an effortless way to spread your money across different investment types and regions so you're that not relying on one to perform well.

What are the different types of funds?

Needless to say, investment funds don’t form a homogenous group. And if you’re just getting started with them, you’ll quickly find that there are multiple types of funds available, and they all have their own characteristics.

So, if you want to get the most out of your investment journey, it could be useful to do some research. Get to know the different kinds you can invest in to work out which may be the best investment funds for you. 

Active vs passive

What are active funds?

Actively managed funds are designed to beat the market and therefore provide investors with higher returns. Though it's important to remember that with all types of investing, your capital is at risk, and you could end up with less than you put in.

To do this, fund managers will pick investments they think could outperform the fund’s benchmark – and this means they'll spend a considerable amount of time analysing market data and researching potential winners on your behalf.

On paper this looks very appealing, but it isn’t without its risks as beating the market is no easy task, even for investment experts! After all, financial markets are unpredictable, and they can be impacted by things like economic trends and global political events.

So, there is a chance that your fund manager won’t deliver the returns they may have forecasted. But this isn’t the only reason for choosing this type of fund.

Investing in active funds means that you have someone choosing and managing your investments for you, which means that if you’re an ethical investor, someone is carefully monitoring each investment’s credibility to ensure it fits in your fund. We’ll go into this in a bit more later.

This does mean that active fund charges may be a bit higher depending on the provider you’re using. So, before you commit, make sure you’re comfortable paying more for this expertise.

What are passive funds?

But active investing isn’t the only route you can take. If you’re not convinced by active funds, why not have a look at passive funds instead?

Rather than trying to find winners, passive funds are designed to mirror the collective returns of the market, minus a small fee.

Put simply, they'll track a specific benchmark index – for example, the FTSE 100 or the S&P 500. This means that the performance of your investment will depend on how well the benchmark indices are doing.

Say you invest in a fund tracking the FTSE 100. Your returns will basically follow the performance of the UK market. So, if the FTSE 100 goes down 10%, your investment will likely fall at a similar pace, and vice versa.

One benefit here is that passive funds tend to be cheaper compared to active funds – this is because you already know what the fund needs to hold so you don’t need as many analysts to do the work of deciding what goes into them.

So, which is better?

Both active and passive funds have pros and cons, and at the end of the day, the choice of which to go with is completely up to you.

With active funds, you'll get an expert who works hard to try and beat the market. But there’s sadly no guarantee that this will work, and it can be more expensive to invest this way.

On the other hand, with passive funds, your returns will simply follow the performance of the market in exchange for a low fee. This means you’ll need to be prepared for fluctuations in performance, and you may want to remain focused on your long-term goals and not on dips in the short-term.

Mutual funds vs ETFs

The most common types of investment funds are mutual funds and ETFs (Exchange-Traded Funds). So, what exactly are they and how do they work?

Think of mutual funds like a collection of individual investments – a bit like a portfolio, but instead of buying all the underlying assets, you can buy one unit of the fund.

Mutual funds, also known as OEICs (open-ended investment companies) and unit trusts, have existed for a very long time. In fact, the first mutual fund, Massachusetts Investors Trust, was created way back in March 1924!

The main feature of mutual funds is that they can’t be traded on the stock market. Instead, to invest in a mutual fund, you’ll need to send an 'order instruction' to the fund administrator, and this will have to be done via a fund supermarket platform online (or other places).

This also means that mutual funds are only priced once a day. This is typically at 12 PM from Monday to Friday in the UK. If you miss the cut-off time for a day, you’ll have to wait until the following day to place your trades.

What about EFTs?

These are very similar to mutual funds in terms of owning a group of investments. But unlike mutual funds which can only be bought or sold once a day, ETFs can actually be traded on the stock markets at any point of the day during trading hours.

In the UK, stock markets are open 8.00 AM to 4.30 PM Monday to Friday (excluding bank and national holidays).

The benefit? This basically allows you to take advantage of price fluctuations up and down and trade lots of investments all at once.

Income vs accumulation

Investment funds typically come in two variants – these are 'income funds' and 'accumulation funds'. And as the name implies, income funds will provide you with an income.

Put simply, you’ll receive a dividend payment from the fund's provider if you’re investing in a fund of shares, or an interest or coupon payment if you’re investing in a fund made up of bonds.

The frequency of these payments can vary from quarterly, semi-annually, annually or with no regular defined periods.

With income funds, you will typically receive a cash payment which can either be paid into your bank account, or at Wealthify, we will reinvest any dividend or interest payments you receive back into your Investment Plan to give you a chance to earn additional profits from your profits.

Accumulation funds are about growth rather than income. So, instead of the fund provider paying you dividends and interest, they will reinvest all your earnings back into the fund, which could help boost your investment pot.

By having everything reinvested, your profits could generate further profits and over time, your money could snowball thanks so something we call 'compounding'.

At Wealthify, our focus is to provide you with long-term growth, so we make sure to use accumulation funds to build our portfolios, although we’ll occasionally use income funds as well.

Ethical funds

Now let’s tackle ethical investment funds! This type of investing is about maximising potential profits whilst supporting companies committed to driving positive change in society.

And a good way to invest ethically is to purchase ethical funds. Most funds will exclude activities that are considered harmful to the environment and society – typically they will screen out the ‘sin stocks’, which includes the likes of weapons, tobacco, gambling, and adult entertainment companies.

However, some ethical funds will take the exclusion process a further and remove companies that are linked to things like deforestation and fast fashion.

In addition to screening out certain sectors, some ethical funds will pro-actively seek companies that are striving to make a positive difference in various ways. To make their selection, fund managers will use ESG (Environmental, Social and Governance) criteria to assess the ethical profile of each company they look at.

As part of this, they'll check a number of things like:

  • How much energy an organisation uses
  • How diverse its workforce is
  • How transparent it is when reporting publicly

Each company that's looked at will receive an ESG score and the higher this rating, the more likely the company is to be included in the fund.

Active vs passive ethical funds

But not all ethical funds are the same!

Remember the distinction we made between active and passive funds earlier? Well, this can actually have an impact on what you're invested in through ethical funds.

When it comes to selecting companies that do good, passive ethical funds use a rigid scoring system that looks at things in black and white. This means they'll automatically exclude entire industries and judge companies solely based on their ESG score.

In comparison, active ethical funds can dig into company’s credentials and consider organisations that are working to improve their practices.

They'll also actively monitor companies and their activities over time to ensure they either maintain high ethical standards or continue to make progress.

And that’s not all! Active ethical funds can push for change as fund managers can use their power to influence the overall strategy of a company.

At Wealthify, although we use passive funds for our Original Plans, we prefer actively managed funds for our customers' Ethical Investment Plans. This is because we believe that targeted engagement by active fund managers will help drive change in companies.

How to invest in funds

Before you do anything, you may want to think about the types of funds you’re more comfortable with. This decision will mainly depend on your investment goals, attitude to risk, and personal preferences.

Once you've determined this, there are two main ways to invest in funds:

Option 1: choose your own using a DIY platform

This approach gives you full control over what you invest in but requires time, a lot of research, and a bit of financial knowledge to boot.

So, if you’re too busy to do this or just don’t feel confident enough to, don't think that you can't invest. There are many investment services that will choose your investments and manage them for you (like Wealthify, for example).

Option 2: use a robo-investor to do it all for you

With robo-investors, like Wealthify, you don’t have to do any of the hard work. This is because we have a team of investment experts who will do the technical bits for you.

They'll pick the funds you invest in and adjust your Investment Plan over time to help keep it on track as and when things change.

You just need to let us know how much money you want to put in, choose the level of risk you want to take, and decide whether you want an Original Plan that use passive funds, or an Ethical Plan that use actively managed funds to help you invest in companies that are having a positive impact.

We’ll then take care of everything else. Who knew investing could be that easy?

The tax treatment depends on your individual circumstances and may be subject to change in the future.

Wealthify does not provide financial advice. Seek financial advice if you are unsure about investing.

Please remember the value of your investments can go down as well as up, and you could get back less than invested.

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