Investing in Funds

When it comes to investing, there are no guarantees. Past performance is not a reliable indicator of future results. Your investments can go down and up in value, so you could get back less than you put in. It is generally recommended that you hang on to your investments for at least five years, to give your investments the best chance of providing the returns you’re hoping for. Even if you wait five years, you might still get back less than you put in. It would help if you were comfortable with this before you begin.

When you buy a unit of a fund, you are investing in a variety of investments at a relatively low price. Such investments could include:

1. Shares
   When you buy a share, you own a small unit of a public company. So, if you buy a share in Apple, for example, you become a part-owner of Apple. If it performs well, you’ll benefit from its success. If it doesn't, you may lose some money. Shares are also called equities or stocks.
2. Corporate Bonds
   When you invest in a corporate bond, you are lending money to a company in return for interest.
   
3. Government Bonds
   ‍When you invest in a government bond or gilt, you are lending money to a government in return for interest.
4. Commodities
   ‍When you invest in commodities, you are investing in precious metals (gold, silver), oil, agriculture, etc.
   
5. Properties
   ‍When you invest in property, as the name suggests, you are investing in real estate.
   

Funds usually have a specific theme or sector around which all investments are structured. Themes tell you which area of the market a fund is invested in, allowing you to make a preliminary judgment on the fund's risk level and to invest in alignment with your interests, values, and objectives. For instance, if your ethical values are a factor when choosing your investments, you might be inclined towards investing in funds with a socially responsible or green theme. Fund themes could include but are not limited to:

1. Company size: large, medium, small, unicorns, etc.
2. Asset type: shares, corporate bonds, government bonds, commodities, etc.
   
3. Industry: real estate, technology, utility, etc. 
4. Geography: American, British, European, Emerging Markets, etc.
5. Ethics: companies with high Environmental, Social and Governance (ESG) scores

Funds are managed either actively or passively by the fund manager in charge. You can decide to invest in either active or passive funds or both.

Active funds
These are funds that are actively managed by a team of fund managers. These fund managers employ various strategies to pick shares or bonds they think will do well with the goal of outperforming the stock market and other competing funds. But, there are no guarantees. While some fund managers certainly beat the stock market and reel in huge chunks of returns for investors, others don’t.

• Active funds are usually more expensive than passive funds because you pay extra for the active service.
• Most funds in the market are active. Investment providers always tell you whether funds are active or passive.

Passive funds
‍Passive funds (also known as tracker or index funds) are different from active funds in that rather than attempt to beat the market, the fund managers track it. This means that instead of picking individual shares or bonds they think are going to do well, fund managers often buy shares in every company listed on an index with the goal of performing exactly as the index does.

An index is simply a list of shares or bonds in any given market. You may have heard of the FTSE 100 index. It is an index of the 100 largest companies on the UK stock market. A passive fund tracking the FTSE 100 index, for example, will buy shares in all the companies on the index. So, if you purchased a unit of this FTSE 100 index fund, you’ll have purchased a tiny fraction of an investment in the 100 largest companies in the UK stock market.

• Most people invest a portion of their retirement savings or personal pension in passive funds as they are less volatile than their active counterparts. Passive funds tend to deliver healthy returns over a long-term period.
• Passive funds usually have lower fees compared to active funds.
• Examples of passive funds include index funds and exchange-traded funds (ETFs). ETFs and index funds are pretty much the same thing, with the main differences being that ETFs are traded on the stock market (this means you can buy or sell them at any time during the day just like shares) and sometimes, they have extra fees.

When you invest in funds, you might receive regular income from your investments. Many funds give you the option to collect this income or to reinvest it in your portfolio automatically.

If you choose "income," you will receive income in your bank account regularly. This income comes from dividends of the companies the fund invests in.
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If you choose "accumulation," your income will be automatically reinvested, which will increase the total value of your investments and, by extension, the price of each unit of the fund. Most people investing to grow their money in the long term usually buy funds of the accumulation class.

Once you are ready to invest, you'll have to pick a provider and choose funds from the selection offered by your provider. You should know your objectives, risk appetite and have a rough idea of the kinds of investments you want in your portfolio. It would help if you also planned to invest for at least five years and ensure that you are not heavily indebted or cash-strapped before you begin.

1. Know your objectives.
   Why are you investing? Is it for retirement, buying a home or some other long term goal? Most people investing for retirement will have their eye on passive funds, for example.
2. Consider your risk appetite.
   The higher return you want, the more risk you'll have to be willing to accept. It's usually wise to take on more risk when you are young with many years ahead of you to ride out any dips in the market. As you grow older, you'll be more inclined towards medium and low-risk investments.
   
3. Keep an eye on costs.
   ‍There are several charges associated with investing in funds. These charges are usually displayed as a flat fee or a percentage typically below 1%. While that may not look like much on the surface, costs tend to add up over time. As a general tip, percentage-based charging tends to work out cheaper for people who do not have a lot of money to invest. In contrast, flat fees are usually cheaper for people who have a lot of money to invest.
4. Unity in diversity.
   Using the fund themes above, you can build a diversified portfolio of funds based on your interests and objectives. We emphasise diversity because top-performing funds vary from year to year, so investing in different asset types (e.g. shares, bonds) and different geographies (e.g. America, Europe, Emerging Markets), for example, is usually a good idea. This way, you are never overexposed to just one market. It is also important not to be too diversified. If you have an over-diversified portfolio, it can only ever be average.

Thinking about these should help you decide whether to invest in passive or active funds, income or accumulation fund class, socially responsible or regular funds and funds with flat or percentage-based fees. Once you're done thinking through the above, you may use our top picks provider list below as a general guide and starting point to understanding and choosing investment platforms. Depending on how you plan to invest, you may need help choosing from the large pool of funds on offer. Most investment platforms provide fund suggestions and investment ideas on their website. Several platforms also publish their top-performing funds and most-traded funds lists. Finally, have a look at this Spot the Dog guide by Bestinvest - it shows underperforming funds you probably want to avoid.

It is straightforward to begin investing in funds. You can open an ISA, personal pension or general investment account with providers such as fund supermarkets, stockbrokers, banks and other financial institutions. The cheapest way to invest in funds is by using investment platforms known as fund supermarkets. Fund supermarkets give you a wide range of funds to invest in, and you can buy, hold or sell funds within these supermarkets. We've listed a few fund supermarkets and investment platforms in our top provider list below. You may use this list as a general guide and starting point to understanding and choosing investment providers.

When investing in funds,  a Stocks and Shares ISA should always be your first port of call because you do not pay any taxes when you hold funds in a Stocks and Shares ISA and you can access your money anytime. You'll find more information about the taxes below.

Yes, provided the platform you are switching to sells the same funds as the old platform. If this isn’t the case, you’ll have to sell your funds in the old platform and start afresh with different funds in the new platform.

Yes. Note that percentage-based charging tends to work out cheaper for people who do not have a lot of money to invest. In contrast, flat fees are usually cheaper for people who have a lot of money to invest. You can find full details of a fund’s charges in its Key Investor Information Document (KIID). See the main charges below:

1. Annual Platform Fee
   ‍‍This is charged by the investment provider for providing a platform for you to invest.
2. Annual Management Fee
   ‍‍Also known as Ongoing Charge Figures (OCF) or Total Expense Ratio (TER). This is the fee paid directly to the fund manager responsible for managing your funds. When you invest in funds, you typically select a few funds to invest in. If you selected three different funds, for example, you would be required to pay a management fee on each fund.
   
3. Annual Investment Cost
   ‍‍Some providers display this cost as the annual management fee plus a market spread or just the market spread.
4. Trading Fees
   ‍Also known as dealing fees. This is the fee for buying and selling funds or other types of investments on the platform. It usually ranges from £0 to £25. If you plan to buy and sell a lot, you would probably be interested in platforms with lower trading fees.
5. Transfer Out Fees
   ‍Also known as exit fees. It is the fee you pay for moving your investments from one provider to another. Consider, for example, if you decide to move your investments from AJ Bell to Barclays, you’ll need to pay an exit fee. That said, not all platforms charge an exit fee. But the ones that do, typically charge per fund or holding. You want to be mindful of that.
6. Advice Fee (Optional)
   ‍This is only paid if you opt in for personalised financial advice.

Yes. You enjoy tax benefits when you hold your investments in an ISA or pension. This tax year (2020 - 21), you can invest up to £20,000 in a Stocks & Shares ISA tax-free. If you choose to invest in a general investment account (non-ISA), you are allowed to make £12,300 of gains tax-free. Additionally, the first £2,000 you receive in dividend is tax-free. Read our Stocks and Shares ISA Guide for more information.