Funds

A fund is a type of pooled investment, which gives investors access to a spread of companies. 

They are structured as either unit trusts or open-ended investment companies (OEICs), but in practice there is little difference between the two as far as private investors are concerned. A full explanation, though, can be found on our Unit Trusts & OEICS page. 

With funds, there are two investment styles: actively managed funds (in which the choice of companies is made by a professional fund manager) and passively managed funds (which invest in the constituents of a stock market index and therefore follow its fortunes up and down). 

Each investor in a fund receives shares or units, which represent a portion of the holdings of the fund.

Funds are sometimes known as 'mutual funds', although this is not a commonly used term in the UK.

Active funds
An actively managed investment fund has an individual fund manager (or a team of managers) who make investment decisions for the fund. Investors who buy active funds hope the fund manager(s) will outperform rival active funds and a comparable stock market index.  

Passive funds
Passive funds, also known as index trackers, tracks the up and down movements of a stock market index (such as the FTSE 100) - or a filtered version of it. No active decisions are made – instead the composition of the index is mirrored by the fund. Therefore, investors should expect the return of the fund to be close to the performance of the index, but with a slight lag due to the fund charge. As well as index trackers, passive funds can also be structured as exchange-traded funds (ETFs). 

Broadly speaking funds can be divided according to whether they invest in equities, bonds or property. In addition, there are more specialist funds: some invest in alternative assets (such as infrastructure) and others in commodities (such as gold and oil). There are also multi-asset funds, which invest in a mixture of assets. 

Funds either invest globally or on a regional basis in a developed market (US, UK or Europe) or across Asia and the emerging markets. 

There is not one single fund that meets everybody's goals and needs, but a combination of different types of funds and investment trusts can help investors achieve a diversified portfolio, which helps to reduce risk. A mixed investment approach gives a portfolio ample opportunity to grow, while at the same time helping to guard against serious short-term losses. 

This reflects the fact that different types of investment are unlikely all to outperform or underperform at the same time, which therefore reduces the volatility of your overall portfolio.

If you are not a customer of interactive investor you will need to open an account. It is easy to add funds to your portfolio using our online account.

Our flat fee plans start from just £4.99 a month and give you access to our Stocks and Shares ISA and Trading Account. 

Bear in mind that as well as our fee, funds charge a separate annual fee, which is paid to the fund management company. Actively managed funds tend to have an ongoing charges figure (OCF) of between 0.85% and 1% a year. In pounds and pence this works out at £85 to £100 on a £10,000 investment. Passively managed funds are cheaper, with some index funds and ETFs for two of the main developed markets (US and UK) costing less than 0.1%. A 0.1% charge would work out at £10 on a £10,000 investment. 

The income units pay out any income generated by the fund (such as dividends from shares or coupons from bonds), while for accumulation units, this is simply reinvested back into the fund. 

The income share class is suited to those who want to draw an income - for instance those using their investments to help fund their retirement. In contrast, the accumulation share class is a better choice for those who do not need or wish to have the income generated by the fund returned to them as they are building up their ISA and/or SIPP. Those who pick the accumulation share class will benefit from the power of compounding, which means in effect that investors get returns on their returns. 

'Mutual funds' is essentially another term for investment funds. It is a more common term in the US.