In the first of a news series of articles aimed at beginner investors, self-confessed finance nerd Prerna Khemlani, founder of This Girl Invests, ditches the jargon to explain the world of funds.
So, there are plenty of experts telling you that funds are a better fit for beginner investors than individual shares but...what even are funds? Why do people keep saying they’re less risky? And what’s all this fuss about index funds?
These are some of the questions I had myself when I first started investing - and the more I read online - the more I felt I was going down a rabbit hole.
Below are three things I wish I knew before I started investing in funds (with minimal jargon!):
1) Funds help with diversification
Before we dig deep into the different types of funds, it is important to understand what they really are. The way I like to think of funds is that they are a ‘box’ where many people ‘pool’ their money in exchange for a ‘fund unit’ (think of it as buying a slice of the pie but you don’t know who else is getting a piece!).
That pooled money then gets invested into different assets (shares, bonds, etc), depending on which fund you’ve chosen. The idea is that, over time, those assets make money for you (e.g. if the share price rises, if the shares pay a dividend, and interest from bonds). The returns are then distributed to all the ‘unit holders’ (i.e. you!).
You can decide whether you want to receive the money (dividend payments) in your investment account (if so, choose income units, the ones with Inc at the end of the fund name), or to reinvest the money you make (pick accumulation units, or Acc, if you like this idea).
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It’s a powerful way of investing because investing as a collective is cost-efficient and everyone gets a slice of the pie without having to choose which shares/bonds to invest in themselves. That’s left to the clever fund manager. However, most importantly, you are not putting all your eggs in one basket. You are not placing all your money in one share but across many shares. This diversification is necessary to manage the risk of investing.
2) Funds can be actively managed and passively managed
There are many ways to classify funds, but one of the most common is to split them between: actively managed funds (where a human – a professional investor or fund manager - makes investment decisions) or passively managed (where a robot, or fancy software, are used to run an index fund).
A common type of passive fund is called an index fund - where the fund tracks an index, such as a stock market. In other words, the money is invested in shares of companies in a specific index (e.g. the FTSE 100 or the S&P 500). For example, when you buy a unit in a FTSE 100 index fund or another option called an exchange-traded fund (ETF), you are essentially buying a piece of all the top 100 companies listed on the London Stock Exchange.
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Passively managed funds are also cheaper to buy than active funds, so they are a fantastic way to invest small amounts if you are just getting started.
3) There are as many types of funds as there are stars in the sky
Fund is the word for any collective investment vehicle, including investment trusts – some of which are private equity specialists (this means they invest in companies that you can’t buy on a stock market). You may also hear about funds that focus on specific industries (e.g. funds that only invest in companies in the pharmaceutical sector or technology sector). Really, a fund is just a pool of money collectively invested by many investors. So, next time you find yourself confused about what funds are – just think of a box with many assets in it and you’ll be on your way.
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Prerna Khemlani is the founder of This Girl Invests, which has been featured on Glamour UK and Cosmopolitan UK. This Girl Invests’ mission is to help reduce the gender investment gap by using education as a tool to empower women to invest and to feel #financiallyconfident.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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