In a couple of weeks I’ll be looking at buying your own shares, but for most of us – short of time and stock market expertise – it’s better to leave it to the experts, the fund managers.
The gains may not be so spectacular, but you can set up your direct debit and let someone else take the decisions. Here’s how funds work.
Equity funds pool the cash of numerous individual investors, such as yourself, to buy a portfolio of shares in traded companies.
It means you can buy into a broader range of shares than you otherwise would – giving you exposure to a mix of potential growth stocks. And with your eggs in several baskets, you cut the risk of losses.
Upfront charges are reduced too, as funds get discounts on their dealing costs.
Further, if you regularly invest a set sum over a long period, then even the dips and peaks in the stock market can work in your favour.
This is down to a thing called pound-cost averaging. Let’s say you invest £100 a month into an investment fund, which buys a basket of shares across the market.
When share prices fall, your £100 buys more of these good value shares. Conversely, when prices rise, you buy fewer of a relatively overpriced share.
You don’t have the worry of over-investing at the top of a market which may fall. And your value priced shares have lots of potential to grow.
The classic collective fund is the unit trust.
The Trust is the holder of the fund’s assets, with the trustees ensuring the fund manager adheres to the fund’s investment objective. That could be to deliver income, or growth, to buy heavily in a specific market, to be adventurous or cautious, and so on.
Unit trusts are open-ended, so new people can buy in all the time. As you invest money, new units are created to reflect that cash. When investors sell up, the units are dissolved.
This way the total value of the units ALWAYS reflects the net asset value of the fund.
The trust manager makes his profit on the difference between the purchase price of units (the offer price) and the sale price (or bid price).
Similar to unit trusts, but set up as a company rather than a trust are Oeics – or open ended investment companies.
Your investment will buy a ‘share’ in the Oeic, though these shares aren’t traded on the stock exchange like normal company shares.
A further difference is that there just one price, for buyers and sellers.
This is intended to be clearer and fairer to investors, though sceptics would point out that there is plenty of room for the funds to make extra money in the charges they make to investors.
Next we have Investment Trusts – set up as limited companies to buy shares in other companies.
Unlike the previous two, these are ‘closed ended funds’, with a limited number of shares being issued. Shares in the trust can be bought and sold, and some of the trusts go back two hundred years or more.
What you are buying in an investment trust is, ideally, a long-term expertise in a specific area – China, rubber, oil or aerospace say.
Finally, Exchange Traded Funds or ETFs offer shares, which you can buy and sell, and which are quoted on the stock exchange. Just like other shares in fact.
Unlike our other common investments, ETFs don’t buy shares in other companies but track the stockmarket indexes, such as the FTSE 100.
This tracker approach means low management fees, often half a per cent a year or even less.
Whichever you buy, there are important things to establish.
First, who are these guys you’re trusting with your money? They are making all the buying decisions on your behalf, so you’d better be happy with them.
What are the charges? A 1.5% management fee each year can knock a huge hole in your investment.
Upfront fees are even worse, with some funds charging you 6% to buy in. Don’t buy direct from the fund but go to a discount broker instead.
And check how transparent the fund is about charging – are you clear how much of your regular payment is actually being invested for you?
You’ll certainly pay less for a tracker fund than a managed fund, as the former simply buys across the market rather than attempting to beat the index.
Trackers are safer, though they’ll never deliver spectacular gains.
It’s worth noting though, that most trackers actually beat managed funds over the long term, by which we mean five years or more. So much for the experts eh?
Finally, it’s vital that you make the most of your tax free allowance by putting your fund in an ISA … check that it’s eligible.
