Understanding the basics
Funds give the investor a simple and convenient way to invest and are popular with both novice and experienced investors alike. In this guide, we are using the term 'fund' as a general description to describe a unit trust/OEIC, investment trust or an ETF (exchange traded fund).
Investing in funds allows your money to be pooled with other investors and have these investments managed by a professional fund manager who will invest in a broad range of assets on your behalf.
Each fund will have an investment objective and this will dictate the asset classes the fund manager will select for the fund's investments. Investors in the fund will receive units or shares which represent a proportion of the underlying investment portfolio.
The main benefit of investing in funds is that the fund manager will make all the investment decisions for you based on the objective of the fund. Fund managers are professional investors who analyse and research the markets and invest in the best opportunities for fund growth and income.
Individual investors only need to concern themselves with the overall fund performance over time rather than having to make individual investment decisions on a daily basis.
One of the other key benefits of investing in funds is the cost. Investing as an individual in a portfolio of equities can be expensive and these costs can be dramatically reduce when sharing these costs with all the investors in a fund.
As with all stock market investments the value of any investment can go down as well as up so it is important to understand your attitude to risk.
Passive and active investment
There are two ways a fund can be managed:
Passively managed funds are usually designed to track the performance of a certain stock market index, hence they are often referred to as tracker funds. Tracking an indices such as the FTSE 100 offers a convenient and simple way of gaining exposure to a broad range of shares that make up the chosen index. Performances can vary between different funds covering the same index which is a result of how they are structured, the method of tracking the indices, and costs.
Actively managed funds are funds where the manager selects the underlying investment held in the fund on your behalf. Their aim is to outperform the market over time but many do not achieve this goal.
The costs involved in both these funds are different and can be a deciding factor for investors when making their choice. Due to the high level of involvement by the fund manager with actively managed funds the costs are higher, with the more automated nature of passive funds these costs are reduced.
Charges
There are a range of charges that can be apportioned to the investor when investing in funds.
Initial charges
Some funds have an initial charge which can be as high as 5%. This charge is typically reflected in the difference between the buying price (offer) and selling price (bid). With the advent of fund supermarkets and platforms these charges can be heavily discounted or in some cases waived altogether.
What are income and accumulation units?
When investing in a unit trust, units are the way fund investments are measured. All investors will buy a number of units in a fund and these units are revalued over time.
Income units are units that reallocate to the investor any dividends paid by the constituent companies within the fund. An investor who is looking to create an income from their investment should invest in Income units.
Accumulation units are units where any income received from dividends is rolled up and purchases more units in the fund and, therefore, increasing the growth potential of the fund.
Some funds offer both types of units and even if your investment is in income units you can still choose to have this reinvested when it reaches a certain amount.
Annual charges
To pay for the costs involved in managing a fund an annual charge is levied, this charge is calculated on a daily basis and factored into the price of the fund.
Other charges
There are other fees that are often charged in relation to operating a fund such as fees paid to trustees and auditors and, in some cases, a performance fee where a fund meets certain performance targets.
It is important that all the charges related to a fund are understood before any decision to invest is made. All charges will be explained in the relevant fund factsheet.
Dealing
Unlike equities that trade and are priced continuously through the hours that the markets are open, unit trusts are only valued once a day at which point the fund’s underlying investments are valued and this, less charges, will dictate the unit value for the fund on that day. ETFs and investment trusts are traded like shares and their prices fluctuate throughout the day.
All dealings in unit trusts are settled on the next valuation point, so you will not know the unit price of a unit trust before you make an investment or a withdrawal. Dealing on investment trusts and ETFs happens the same day.
Fund sectors
Funds are classified by the Investment Management Association (IMA) into groups or sectors (as you can see in our 'Best of the Rest' section). These sectors will define the areas of investment for each fund making it easier for investors to identify funds that meet their investment requirements.
Different sectors are exposed to different risks, such as currency fluctuations for overseas sectors and investors must understand these risks to ensure the fund fits with their risk profile.
Spreading investments across a range of sectors can help to create a balanced portfolio as well as providing access to different fund managers with varying investment approaches. A balanced portfolio can provide an element of protection against poor fund performance or other economic issues affecting individual sectors.
Tips on fund selection
Do your research
That's where 80-20 Investor comes in.
Diversify your investment
To try and achieve a consistent growth in your investments it is important to spread the risk and not commit too heavily in to one fund or sector. If you limit your investment to one sector or asset class you are only likely to be right some of the time and may find your investment slumps just when you need to access your money.
Mitigate risk
Some funds are considered a more risky investment than others due to the volatile nature of their underlying investment. Impressive performance over the short term can be followed by a longer period of underperformance. Checking the funds risk and reward ranking will give you a good indication of its volatility. At 80-20 Investor we do this for you.
Impact of costs
When you are looking to invest in funds you need to understand the costs involved. Initial charge, annual charge and in some cases a performance charge can all have an impact on the performance of your investment. It is unwise just to select a fund on the low cost structure alone but you certainly need to understand these cost and use this knowledge as part of your selection process. 80-20 Investor lets you do this easily. The recent growth in fund supermarkets and fund platforms has driven down some of the costs involved in investing in funds and carrying out a bit of research in this area can have a significant impact on your investment.
How to buy funds
Lump sum or regular investment
Investing in funds is available to all types of investor from monthly investments as low as £50 per month through to large lump sums.
Investing a sum of money on a regular monthly basis can build up a significant investment over time, and this ‘drip feed’ type of investment can also reduce the impact of market fluctuations.
ISAs
Placing your investment within an Isa ‘wrapper’ will mean there will be no liability to capital gains tax (CGT) or further tax on income. The tax free nature of an ISA will mean higher net returns on your investment.
