Why funds are an easy option

When it comes to investing, most retail investors have clear choice: buy shares or bonds from individual companies or put your money into funds run by experienced managers.

There are pros and cons with each approach and some investors will end up doing both.

Here, we take a look at each option to help you decide which best meets your needs.

The pros and cons of buying individual assets

The first option is to buy shares or bonds in a company you like via a stockbroker. This means you are totally exposed to the fortunes of that business, which could be a blessing or a curse.
If the company does better than the stock market expects, you could end up making a handsome profit as its share price rises sharply.

For example, if you bought 10 of the company’s shares at £20, your holding would be worth £200. However, if the share price doubles to £40, the value shoots up to £400.

Of course, the opposite is also true. If the business underperforms or is adversely affected by economic issues, shares could plummet. This will reduce the value of your investment. Remember, however, that prices can recover, and you’ll only crystallise the loss by selling the shares at the lower level.

There are also other factors to consider. Buying into individual companies means you’re responsible for making projections about that firm’s prospects. The research will be down to you and will largely be based on a combination of company statements, published analysis, and your own opinions.

For example, if you believe a pharmaceutical company has a potentially life-changing drug in the pipeline then you may be tempted to snap up some shares.

What is an investment fund?

A less volatile alternative to buying individual shares is putting your money in an investment fund that buys a wider variety of assets. These products see money from a number of investors ‘pooled’ together and looked after by a specialist, full-time manager who will make the investment decisions.

There are two clear benefits: Your returns won’t be dependent on the fortunes of just one or two companies, and you’ll have the experience and resources of an investment professional.

Funds will have different objectives. For example, some will pursue capital growth, while others focus on delivering an income. They will also invest in differing company sizes and geographies, and some will invest in lots of different assets. Multi-asset funds, for example, might invest in shares, bonds, commodities, property and much more.

It’s also important to note there are both passive and actively managed funds. A passive portfolio will track an index, such as the FTSE 100, by ensuring it has exposure to all the stocks.

Actively managed funds, meanwhile, will have greater freedom to buy and sell various companies to improve their chances of delivering decent returns.

In terms of fund charges levied, passive investing is cheaper than active. However, only with the latter will you have a chance of delivering bumper outperformance.

And of course, you can always invest in more than one fund.

How do funds work – and why are they worth considering?

There are different types of funds. For example, open-ended investment companies (OEICs) are split into units that you buy when investing. Their value will fluctuate depending on the performance of the various assets in which the fund is invested. However, the hope is they rise over time.

It’s down to the managers of these funds to carry out in-depth analysis on individual companies and gain a thorough understanding of these businesses. Their research will include having regular meetings with senior management figures to determine whether the stock market has formed an accurate valuation. Chosen stocks – and the actual number will depend on the fund’s approach – will then be monitored closely with the exposure to companies increased or decreased accordingly.

As well as OEICS, you have investment trusts. While these pool investors’ money in the same way as OEICs, investment trusts are themselves companies listed on the stock market and investors buy shares in them.

However, the price of these shares will be determined by supply and demand issues rather than the value of the underlying assets in which they invest.

Investment trusts are known as closed-ended as there will only ever be a set amount of shares available. They also have several other potentially attractive qualities.

For example, in good periods they can hold back some of the income they make, which can then be distributed in the future. This enables them to smooth out the returns generated.

Find out more about investment trusts here.

The types of funds and trusts that are available

The good news is that whatever your investment goals or attitude to risk, there’s likely to be an investment fund or trusts to meet your needs.

The Investment Association – a trade body for the investing world – divides the 3,000+ available open-ended portfolios into sectors based on the funds’ aims and objectives. Currently, there are around 50 such sectors covering a variety of asset classes, including equities, fixed income, and property.

The Association of Investment Companies does a similar thing for all the investment trusts available.

While the vast array of funds and trusts available means there is lots of choice for investors, the sheer number can be overwhelming. That’s where FundCalibre can help. Our fund research team looks at all the funds and trusts and narrows them down to a much more manageable list of around 200, that we believe are the top of their class.

Find out how FundCalibre picks funds here.

This is step 3 of 5 in our “5 steps to investing” — continue to step 4: What can you afford to invest? Need to go back to step 2 — The two types of investments you need to know about?

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