CREATED: 12:36 GMT, 13 January 2010 UPDATED: 09:09 GMT, 14 April 2014
Article from http://www.thisismoney.co.uk/money/
Investing in funds is the route often recommended to small investors by the experts - allowing them to
pool their money with others to access a range of investments and avoid putting all their eggs in one basket.
There are a variety of ways to do this, from the most popular 'fund' options, to investment trusts and exchange traded funds.
Some tap into professional's expertise while others simply track a certain index, some follow popular markets while others allow access to obscure and adventurous corners of the world.
We explain what funds are, how to invest, and how to save money by becoming a DIY investor and using a fund supermarket or platform.
What are funds?
When investors talk about funds they are typically referring to either unit trusts, or open-ended investment companies, Oeics.
These may sound complicated but they are essentially just funds where investors' money is pooled to invest in shares, bonds or other funds.
The idea is that as the fund invests in lots of different companies' shares or bonds, the risk of you losing all your money is less than it would be if you were in a single company's shares.
Similarly, most funds will have a fund manager. This will be someone, typically with substantial investing expertise and experience, who will aim to beat the market and provide the best return for investors (although, often they do not manage to do so.)
When times are good a fund manager aims to do make higher gains than their peers, when times are bad a good manager will come into their own by continuing to make money, or just not losing as much as their peers.
Investors have to make a minimum investment, usually £500 to £1,000 to access a fund, and their investment will either go up or down in value depending on how the fund has performed.
Investment funds, the typical term for Oeics and unit trusts, carry two sets of charges - an initial charge, which can take a chunk of your money when you put it in, and annual management charges, which go towards the cost of paying the fund manager and running the fund.
Initial charges can be up to 5 per cent but are easily avoidable through a good broker or platform. You do not want to be paying these. Annual management charges vary, but have traditionally been around 1.5 per cent with half of that going to financial advisers and platforms that sold the fund.
This is changing due to new financial regulations stopping these payments and new clean funds have been brought in, which typically charge 0.75 per cent to 1 per cent and pay no commission back to advisers or platforms
Investment trusts have typically had lower charges and did not pay any commission to advisers or platforms.
Annual management charges are taken from your investment every year and act as a drag on its performance.
The annual management charge is not the true cost of investing, however, a closer estimate is the total expense ratio or its replacement measure ongoing charges.
A good DIY fund or Isa investing platform will slash these charges [Read more: The best (& cheapest) Isa investing platforms]
The best way to invest is through an Isa wrapper which shields your investments and their growth from the taxman.
Passive or active funds
To complicate matters funds are typically divided into two categories active and passive.
Around one in four funds is passive, there is no stock picking involved, it simply buys the shares or market represented and therefore tracks it, ie a fund that mirrors the FTSE 100 and will deliver the same returns as that market.
An active fund on the other hand has a manager buying and selling assets, attempting to beat the market.
Some tracker funds are far more sophisticated than others. For example, Vanguard's LifeStrategy range and rivals allow investors to choose their risk levels and then buys a basket of assets that suits them, across shares and bonds around the world.
The advantage of a passive fund is that it is cheaper. These generally take two forms, either a tracker fund bought and sold in the same way managed funds are, or an Exchange Traded Fund, bought and sold in the same way shares are.
This low cost investing has become increasingly popular in recent years, especially ETFs which offer the chance to trade anything from the FTSE 100 and gold, to coffee beans and cotton.The more exotic the ETF the higher charges are likely to be.
Fund managers will tell you that the advantage of an active fund is their expertise, however, you actually have to choose the right manager to benefit from this, many actually consistently fail to beat their benchmark and still levy their fees - a handful do actually outperform year after year.
There is plenty of debate as to which side of the active vs passive argument is right.
Choosing a fund
There are thousands of funds to choose from and they are divided into different types or sectors. You can buy funds that invest in shares, corporate bonds, gilts, commodities and property, among other things, they will also typically have some form of geographical focus.
The wealth of choice means investors can target any theme they choose but can also make picking one baffling. If you are unsure of how to invest speak to an independent financial adviser
If you are comfortable going it alone, our expert fund tips provide some pointers.
Buying funds and investment trusts
If you go direct to the fund company, you'll lose up to 5% of your investment as an initial charge, that makes this one of the areas of a life where a middleman pays off.
A financial adviser can help - but you must now pay them for their time either through an upfront fee, hourly rate or percentage of your investments, which for many small investors may prove overly expensive.
If you don't want help from a financial adviser, it is cheaper and easier to go through a DIY investing platform or an 'execution-only' broker, who does not give advice. They can provide access to funds, investment trusts and ETFs.
The best way to invest is through an Isa wrapper which shields your investments and their growth from the taxman
This may sound complicated but is actually simple. Once you identify your chosen platform, you can go open an account with them, pick your investments and choose to fund them with a lump sum, regular investments or both.
Platforms are easy to use, the best have helpful customer service on the end of the phone and you can manage your investments online.
What about investment trusts?
Investment trusts are less common and have not tended to be recommended as often by advisers as they do not pay them commission.
The crucial difference between them and funds is that investment trusts are listed companies with shares that trade on the stockmarket.
They invest in the shares of other companies and are known as closed end, meaning the number of shares or units the trust's portfolio is divided into is limited. Investors can buy or sell these units to join or leave the fund, but new money outside this pool cannot be raised without formally issuing new shares.
Investment trusts can be riskier than unit trusts because their shares can trade at a premium or discount to the value of the assets they hold, known as the net asset value.
For example, a trust's price can fall below the total value of its holdings, if it is unpopular and people do not want to invest but do want to sell, thus pushing down demand and driving up the supply of its units for sale. This gives new investors the opportunity to buy in at a discount, but means existing investors holdings are worth less than they should be.
Investment trusts tend to be a lower cost option than funds, with no initial charge and lower annual fees, however, buying incurs share-dealing charges, again a good DIY investment platform will cut these.
Research has show that investment trusts have in many cases delivered better performance than funds over time. Investors should be aware, however, that buying investment trusts can carry more risk.
Firstly, the share price at which you can sell out could fall to a level below the value of what the trust holds, whereas an open-ended fund's price always reflects that underlying value. Secondly, investment trusts can borrow to boost returns, under a process known as gearing, when times are good this can deliver market beating returns but when share prices fall it can spell a bigger dip in an investment trust's value.
There is an added advantage to investment trusts, however, in that if markets fall and investors rush for the exit they are not forced to sell assets at unattractive prices to let them redeem their investment, as an open-ended fund would need to.
Instead, an investment trust can opt to sit tight and ride out the storm and those who want to sell out will simply find the market between buyers and sellers sets the price of their shares in the trust.
Simon Lambert
CREATED: 12:36 GMT, 13 January 2010 UPDATED: 09:09 GMT, 14 April 2014
Article from http://www.thisismoney.co.uk/money/
