In this course:
1. Int
roduction to Funds
2. The Mechanics of Funds
3. The Benefits of Funds
Introduction to Funds
Deciding where to invest your money can be a difficult decision, particularly if you don’t have the time or inclination to research individual securities. That’s where funds can be a huge help. A fund brings together people who want to invest, pools together the group's money and invests it for them in a collection of securities, such as equities or bonds or a combination of the two.
The Mechanics of Funds
When you buy a fund, you're actually buying an interest in a pool of assets—“units” or “shares” of the fund. The price of a share at any time is based on the net asset value, or NAV, of the fund’s portfolio. The fund, if it’s a unit trust, may quote bid and offer prices, and if it’s an open-end investment company (OEIC), you may be asked to pay an initial sales charge on top of the NAV. The fund takes your money and combines it with any other new investments and the money that's already invested with the fund. Altogether, those investments are the fund's assets. The fund invests its assets by buying shares, bonds, or a combination of such securities. These equities or bonds are often referred to as holdings, and all of a fund's holdings taken together are its portfolio. (A fund's type depends on the types of securities it holds. For example, an equity fund invests in shares, while a small-company fund focuses on the shares of small companies.)
What you get as an investor or shareholder is a portion of that portfolio. Regardless of how much or how little you invest, your shares are the portfolio in miniature. For example, Fidelity Special Situations' four largest holdings are Tesco (5.70% of its portfolio as of February 2007), Reed Elsevier (4.34%), Vodafone Grp (4.31%), and Statoil (3.02%). Your £1,000 investment in the fund means you own £57.00 worth of Tesco, £43.40 of Reed Elsevier, and so on. In an indirect way, you own the 118 equities in the fund's portfolio.
The Benefits of Funds
Funds offer a handful of benefits to investors.
1. Funds don't demand large up-front investments.
If you have just £1,000 to invest, it will be difficult for you to assemble a varied group of equities. For example, if you had £1,000 to invest and decided to buy one share of stock from the largest U.K. company, then one from the next largest, and so on, your £1,000 would run out quickly. If you bought a fund, though, you would get much more. You can buy some funds for as little as £50 per month if you agree to pound-cost average, or invest a certain amount each month or quarter. (We'll cover different investment methods in an upcoming session.) You can make an initial investment in many funds with just £1,000 in hand. If you invest through an ISA or Individual Savings Account, you can often get your foot in the door with even less than £1,000.
2. Funds are easy to buy and sell.
You can buy funds several ways: through financial advisers, directly from fund families, and via fund supermarkets. (We'll discuss these options in later courses.) But no matter how you buy funds, you can buy and sell shares quite easily--often with just a phone call or mouse click. The exception: closed funds. Closed funds no longer accept new money, except, in some cases, from current shareholders. (In later courses, we'll discuss why some funds close.) Investors who own closed funds can sell at any time, though. And when you sell shares of a fund, you get cash in return.
3. Funds offer instant diversification.
It is generally not cost effective for small investors to buy a large pool of securities on their own. With a fund, this problem is easily solved. You can buy access to a single fund that spreads its bets across tens, or even hundreds of securities, multiple market–cap ranges and economic sectors, and different regions. You can also buy a fund that combines exposure to different asset classes, such as equities, bonds, and property. Target-date funds even shift their asset exposure over time to suit your needs—they start out with aggressive growth-oriented allocations, and move to more conservative, income-oriented allocations as they approach their target dates.
Keep in mind, though, that not all funds are diversified—some specialise in a single economic sector, whilst others may focus on a particular area of the market, such as UK small-cap equities. Even with these offerings, however, fund investors are likely to get more diversified exposure within the fund’s area of focus than they would be able to easily build for themselves.
4. Funds are regulated.
Funds can't take your money and abscond with it. The FSA has laid down rules for funds to ensure that they deal in an above-board manner with investors. Some of these rules are contained in the New Collective Investment Schemes sourcebook, or COLL, whilst others can be found in the imaginatively titled: Open-Ended Investment Companies Regulations 2001. We think these rules fall short in some respects—we think the reporting requirements for portfolio holdings are woefully insufficient, for example, and we believe investors would be better served by having independent boards of directors to ensure a fund company isn’t over-reaching. Nevertheless, these regulations help ensure that funds abide by certain basic tenets, do what they say on their label, and cannot steal your money. Apart from a small handful, hoever, funds are not insured or guaranteed. You can lose money in a fund, because a fund's value is nothing more than the value of its portfolio holdings. If the holdings lose value, so will the fund.
5. Funds are professionally managed.
If you plan to buy individual equities and bonds, you need to be able to read a cash-flow statement, understand a balance sheet, and calculate duration. And if you want to diversify into foreign markets or specialised areas such as commodities, the level of expertise required to do diligent research increases dramatically. Such knowledge is not required to invest in a fund. While fund investors should understand how the equity and bond markets work, you pay your fund managers to select securities for you.
Funds are not fairy-tale investments. As you will see in later sessions, some funds are much too expensive, some perform poorly, and others are not shareholder friendly. But overall, funds are good investments for those who don't have the money, time, or interest necessary to compile a collection of securities on their own.
If you enjoyed this article, you may also want to review our recent series on ISAs.
