In this article, we will look at what an investment fund is and the different types available.
We will explore the following areas:
- How do investment funds work?
- Types of investment funds available.
- Advantages of investing in a fund.
- How to invest in a fund.
After reading this article, you should have a better understanding of investment funds.
You will also be able to establish your own opinion on whether investment funds are right for you.
So What Is An Investment Fund?
Investment funds consist of a pool of many different investors.
These groups can number in the hundreds or even thousands of investors.
But what would be the reason for needing to do this?
Well, imagine you were a single investor with only $10,000 to invest.
Your investment options would be very limited with this amount.
Now, imagine if you were to pool your investment together with a group of 9 other investors.
Each person invests $10,000 increasing your total investment to $100,000.
Now that you have a larger investment pot, you will now be able to invest in a variety of investment options.
By spreading your $10,000 across a wider number of investments you are also reducing the risk.
If one investment were to go bad then you still have your other investments to fall back on.
How Can You Invest?
Professional money management companies manage investment funds.
These companies hire fund managers to make the important decisions about what to invest in, so you don’t have to.
It is their marketing departments job to persuade people like you to invest in their funds.
Contacting the companies marketing department is one option for investing in a fund.
Another option is to use a “fund supermarket”.
What Is A Fund Supermarket?
A fund supermarket is often a cheaper and convenient method of investing in a fund.
Fund supermarkets provide an investment platform to its users.
These investing platforms allow you to browse a wide variety of investment funds.
Before investing in a fund you should first find out what you stand to gain and risk.
We will go over the pro’s can con’s for each type of investment fund later in this article.
Are There Advantages To Investment Funds?
There are many people who don’t have the time to manage and watch a portfolio of individual shares.
For those people, an investment fund makes a lot of sense
There are a few advantages to investing this way.
You’d save money on brokers’ fees (the fees you pay for buying and selling shares).
This is because you’d only pay the broker once, not eight times.
You would then be able to invest in a greater number of different companies for a lower cost.
That means your risk is now spread and so you’d be less likely to lose a lot of money all in one go.
And you’d also be able to enjoy the expertise of other club members.
Types Of Investment Funds Available
There are a wide variety of investment funds available to investors, over 8,000 in fact.
The function and goal of each fund can vary depending on the portfolio manager.
Determining which type of investment fund best suits you requires knowing the following:
- Financial needs
- Investment objectives
- Risk tolerance
Money Market Funds
These funds are a fixed income mutual fund that invests in debt securities.
These can include;
- Treasury bills
- Government bonds
- Municipal securities
- Certificates of deposit
- Corporate notes
Income generated is either taxable or tax-exempt depending on the securities invested in.
Money market mutual funds are among the lowest-volatility types of investments.
They are also generally a safer investment.
Money market mutual funds tend to have a lower potential return than other types of mutual funds.
Fixed Income Funds
Fixed income funds are often referred to as bond funds.
Bond funds generally invest in fixed-rate securities.
These include investment-grade corporate bonds, government bonds and high-yield corporate bonds.
They aim to have a regular return coming in on a fixed schedule, mostly through interest that the fund earns.
Fixed income funds are riskier than funds that hold government and investment-grade bonds.
Yet they are still less risky than equities and derivative investments.
A recent article by Forbes made some interesting points about the dangers of a U.S. corporate debt bubble.
Equity or stock funds are simple funds that invest in stocks.
They are one of the most popular types of investment funds.
There are a variety of different types of equity funds available, these include:
- Growth funds
- Sector funds
- Income funds
- Value stocks
- Balance funds
The main goal of an equity fund is for long-term growth through capital gains.
Equity funds tend to be more appealing for smaller investor.
This is because of the smaller amount of capital required and having a diverse portfolio.
What makes these types of funds appealing is the huge variety available.
This means that any one investor can find a suitable fund to meet their requirements.
Unlike trading the stock market, with a fund you do not have to worry about selecting a stock to buy.
You will not actually own any shares purchased by the fund, rather you will own part of the fund itself.
A balanced fund invests in a mix of equities and bonds.
An aggressive balanced fund will hold more equities and fewer bonds.
Whereas a more conservative fund will hold fewer equities compared to bonds.
As the name suggests, this fund tries to keep a balance between achieving high returns and the risk.
It is this balance that has attracted more investors to balanced funds.
Balanced schemes tend to be less volatile than pure equity funds.
This is because the investment in debt helps balance the fund and contain the volatility.
Although less risky than equity funds, they are riskier than fixed income funds.
An index fund aims to track the performance of a specific market index.
S&P 500 Index tends to be the most tracked index, although there also many other indexes tracked such as MSCI EAFE.
The value of the fund will move up or down as the index goes up or down.
In the past, index funds did not fare so well against other mutual funds.
Recently though they have started outperforming other funds on performance.
Index funds now make up 20.2% of all equity mutual funds as of 2014.
Index funds will generally have lower costs than other managed mutual funds.
Portfolio managers don’t need to do as much research and analysis when making investment choices.
Returns for index funds are often a little lower than the tracked indexes.
This difference in returns is known as a “tracking error”.
Specialty funds or specialized funds focus on specialized smaller sectors of the economy.
These can include energy, health and financial services sectors.
To class as a specialty fund, at least 25 percent of its portfolio would need investing into one sector.
With a specialty fund, the aim is to invest in a particular sector at the right moment.
Many specialty funds now put in place a “sector rotation”.
A sector rotation is where the fund switches from one industry to another.
The aim of doing this is to increase the potential returns.
There are generally three main types of specialty funds;
Sector fund – focuses on a particular industry or part of the economy.
Regional fund – invest in companies in specific geographical locations.
Combination fund – is a combination of a regional and sector fund, investments. These consist of investments in a specific industry in a certain location.
There is a much higher potential yield in comparison to most other funds.
Specialty funds can lack the diversity that other funds offer.
They also have a higher risk potential than other funds.
Specialty funds are prone to fluctuations over long periods of time.
This would make these funds unsuitable to those that tend to worry a lot.
The name might give it away, but a fund-of-fund invests in other funds.
A Fund-of-funds investment strategy involves a “Master fund” investing in a variety of other funds.
The portfolio consists of different underlying assets.
This is different as there is no direct investment in Stocks, Bonds and other securities.
This type of fund has a broad diversification and tends to appeal to smaller investors.
This is because it has wider exposure categories and fewer risks.
The high fees charged are one of the biggest drawbacks to investing in FOF funds.
Before investing in a fund you should first check what your requirements are.
Ask yourself the following questions;
Do you need a regular income from the fund?
How often will you need to access your investment?
What are you willing to risk?
Answering these questions should help you select the fund that best suits your needs.
It’s also very important to weigh up the pro’s and con’s of each type of investment fund.
There may be one or two funds that meet your requirements.
By analyzing the pro’s and cons you should be able to limit your selection further.
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