What are funds and how do they work? We explain fund basics and everything you need to know about beginning to invest in funds.
What are Funds
A fund is a collection of investments. They are essentially a way for people to group money together to invest into a number of assets such as stocks and shares. The money is allocated to different investments and often ran by a fund or investment manager.
How do funds work
When an investor puts their money into a fund, they become an owner in the fund, and own their share in the funds’ assets. Their money is pooled together with other investors money to invest in the chosen assets.
Investors hold no say in what investments are chosen, as these are selected by a fund or investment manager who decides which assets to buy, how many of each asset and when to buy them. Funds are typically built around geographical regions, industries or based on stock market indexes amongst other ideas.
All funds fundamentally work in this same way. However, they have unique characteristics which then makes each fund different. These characteristics could be the type of fund they are, whether they are actively or passively managed, the objective of the fund, the classification of shares/units within the fund and the fees charged.
Type of Fund
When understanding fund basics, it is important to know that funds work based upon the way they are formatted. The way in which each fund is set up affects how they can be bought and sold as well as how they are priced.
Each type of fund is required to calculate the Net Asset Value (NAV), by taking the total value of assets minus any liabilities. This creates a valuation which may or may not be used within the pricing of the fund. It sets a guideline to what the assets are worth.
In their simplest form, funds may either be open or closed ended, or lie somewhere in between the middle of the two.
Open Ended Funds
Open ended funds are able to issue and redeem shares/units on a continuous basis to meet demand. This means investors may invest at any point and there is unlimited supply. Shares/units are created for these investors when necessary, and investors will own their share of the funds’ assets once the money has been invested. Shares/units can be purchased directly from the fund itself, usually through a broker.
The price of an open-ended fund is directly linked to its net asset value, therefore reflecting the performance of its assets. In other words, if the value of its assets increases, the shares/units the investor owns in the fund will be worth more. If value decreases, then shares/units are worth less.
Closed Ended funds
Closed ended funds are different in that there are a limited number of shares which can only be bought or sold on the market. They are listed on the stock exchange, at a price which may be greater or less than the net asset value of its shares, depending on how investors see its worth. In other words, their price is based on supply and demand of the fund.
Exchange-Traded Funds (ETFs)
ETFs or exchange-traded funds combine characteristics of both open and closed ended funds. They are typically designed in the format of an open-ended fund and behave similarly but are traded on the stock exchange. This means they can be bought and sold at any point, but the price is typically kept close to the NAV (Net Asset Value) of the assets, just like in open ended funds.
When it comes to dealing with funds, you are most likely to come across open ended funds and exchange-traded funds. These are the most popular amongst investors and make up the majority of funds available to invest in.
What are funds invested in
Funds are a collection of investments. As such, they can be invested into a number of different assets. Funds often have a specific purpose and so will be invested in a certain type of asset of the investment/fund managers choosing. Some of the asset classes funds can invest into include:
- Stocks and shares
Each fund is different. Funds are typically invested in one asset class. However, they can be mixed and made up of a number of differing types of assets. It is useful to know when it comes to choosing a fund what they are invested in. It will help you as an investor decide if the fund has the right risk and potential rewards for you. You may decide you want to invest in a certain type of asset and usually there is a fund for that. It allows a greater level of choice as well as diversification.
Why you should invest in funds
Investing in funds can be extremely rewarding for investors, and with them they bring a whole host of benefits. They are typically regarded as being the best way for investors to see consistent returns and offer an ideal investing situation for both beginners and seasoned investors.
Funds are simple and take away the idea that investing has to be complex. As funds are professionally managed, highly skilled people are aiming to put investors’ money to the best possible use. Investors can simply put their money into funds and have no need to keep constant watch over them, knowing they are being monitored by professionals.
Also, investing as a collective means investors’ are able to benefits from a larger amount of capital, which allows more investment with their money. More investment not only means the fund can buy more stocks, but also leads to greater asset diversification. As funds are a collection of investments, they will typically hold numerous shares in all kinds of companies. Therefore, company risk is offset, and investors are more likely to see positive returns.
How to invest in funds
Funds can be bought the same way as stocks and shares. You will require an account, and a broker. Once you have those, you can begin to choose your funds. When buying funds, you either buy directly from the fund or from the market, which will more than likely be done through the broker.
Open ended funds usually take a day or two whilst orders are processed by the fund/investment manager. Once it has been processed, the shares/units will be created, and you will own the funds. With ETF’s and close ended funds, they can be bought and sold more or less instantly through the secondary market.
Once you understand what funds are, and how they work, you may wonder what is next since you know fund basics. However, it is important to gain as much knowledge as you can to understand funds as best you can. Some options you may wish to consider could be:
- Learn the characteristics of funds
- Learn how to find and choose a fund
- Practice investing
- Invest in a fund
You should ensure you are making progress towards your investing journey. Understanding fund basics will provide you with a platform. However, it is important to keep learning and begin to get to know as much as you can about funds. Once you feel ready, dive right in and begin investing.