Investment funds explained: types of funds and how to invest

Funds are ready-made assortments of investments that offer a convenient way to invest.

Daniel Liberto Last updated on 19 February 2021.
Investment funds explained: types of funds and how to invest

What is a fund?

A fund is an investment, run by professionals, that pools together investors’ money to purchase shares, bonds, property or other assets.

Funds typically hold dozens of different investments – at a fraction of what it would cost to put a well-diversified portfolio together yourself. That diversification can be important as, if one or two investments perform badly, the others could pick up the slack.

What types of funds are available?

There are thousands of funds to choose from. Some are broad-based with a large mandate, while others are more niche and tightly focused.

Funds generally either invest globally or in a specific region, country, or industry. Many will also have a particular strategy, such as:

  • Income: Targeting investments that issue regular cash payouts.
  • Value: Buying investments that appear underpriced.
  • Growth: Picking investments whose valuations are expected to rise fastest.

Which type of fund you choose can depend on whether you need to generate income or are prepared to take on more risk in hopes of a better return, and certainly should fit within and not disrupt the balance in your overall investing portfolio. (More on how to choose a fund below.)

Active or passive?

Another important distinction is whether the fund is actively or passively managed.

  • Active funds are run by a manager, backed by a team of experts, who decide where to put investors’ money (so long as it is within the remit or mandate of the fund). The goal is to deliver higher returns than a specific benchmark or stock market index.
  • Passive funds, also known as trackers, aren’t concerned with identifying winners. Their primary objective is to mimic the performance of a particular benchmark or stock index. For example, a passive fund aiming to perform in line with the FTSE 100 – a list of the 100 biggest UK companies listed on the London Stock Exchange – might simply invest in every company on the list.

The biggest advantage of an active fund is that it has the potential to deliver market-beating returns. However, it’s important to note that this cannot be guaranteed, and while many managers will top the benchmark one year, it’s harder to find those who can do that year in and year out.

A passive fund, meanwhile, will only ever perform as well as the index it is tracking, and when markets are falling they won’t be able to adapt their strategy to try to minimise losses. The big benefit, though, is that it is substantially cheaper. f the scale, whereas investors in passive funds can pay as little as 0.1%.

» MORE: Pros and cons of active and passive investing

How and where to invest in funds?

If you plan to invest alone, you could use an investment platform: websites that enable you to purchase a range of investments and manage them from one location, usually inside a tax-free wrapper, such as an individual savings account (ISA) or self-invested personal pension (SIPP).

» COMPARE: Self-invested personal pension providers

How many funds to invest in?

While diversification can be key to successful investing, that doesn’t necessarily mean you need to invest in lots of funds. Buy too many funds and you could find yourself with duplicate investments (lots of funds will buy the same shares) and too much to manage.

You might start with one core fund with a broad remit — tracking a market index, say. Once your knowledge increases and your investment pot grows, you can consider adding funds with alternative or narrower focuses to complement your portfolio.

How much does it cost to get started?

You don’t need to be super-wealthy to get started. Sometimes a small lump sum per month is all that’s required. However, you do need to be able to afford to commit this money for long periods and also fully understand the risks of investing.

How to choose the best fund

Don't just purchase the first fund you come across. Take advantage of the research, tools and guidance on your chosen platform to help you find the right choice for you.

Among the most sensible considerations to make are:

  • Does the fund's strategy match mine? The fund universe is vast, and strategies and risk levels vary. Think about what you wish to achieve, how much you can afford and the prospects of each fund’s holdings.
  • What fees does the fund charge? Fees eat into returns, so it generally pays to choose funds that cost less than similar competitors with comparable performance.
  • What is the fund's track record? If you are choosing an active fund does it outperform its peers over a reasonably long spell? Seeing how it fared when markets are falling is as important as how it performed when they are rising.

Often, the platforms you use to invest will provide you with a handy shortlist of recommended funds. These can be helpful, but they are not without their critics. Find out how funds are selected for lists first, and then use them as a starting point for your own research to work out whether they are right for you.

Finally, when you buy a fund you may be given a choice of buying income or accumulation units (marked up as inc or acc). Unless you need the income, it could be worth going for accumulation units where any dividends are reinvested. Automatically buying more units with the income payments you receive will increase the amount of dividends you get next time, enabling you to purchase even more shares and so forth.

» MORE: Basic investment strategy options

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in

About the author:

Daniel is a freelance finance journalist. He has written and edited news, deeper analysis features, and opinion pieces for the Financial Times, Investopedia and the Investors Chronicle. Read more

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