What is an investment fund (and how do investment funds work)?

If you want to grow your money you may have considered investing it.

Investing is a way to try and put those pounds to work… Rather than having cash sitting idle in a current account (where the interest rates offered may not even be enough to outpace inflation).

However, with investing there are no guarantees. You could lose money if the value of your investments decreases over time.

With money at risk and a wide range of different investing options available, no wonder inexperienced investors may put off investing money. And this can be really detrimental to their long-term financial strategy.

For those of us who don’t feel confident selecting individual company stocks, or who want an accessible way to quickly build a diversified investment portfolio, professionally managed funds may be the answer.

What are funds in investing?

A fund is a pool of money from lots of investors that is used to purchase a collection of different securities, like stocks/shares and bonds (more below).

Each investor will buy a portion of the fund, with any changes to the overall fund value reflected in the market value of their share. Common asset classes that you may expect to find in an investment fund are:

Stocks/Shares

A share is a unit of ownership for a business. A company can raise money by issuing stock and selling a fixed number of shares on the stock market.

Bonds

A bond is the investment version of an IOU. When you invest in bonds, you are effectively lending money to someone (a government or business).

You may also come across funds that include real estate, commodities like precious metals and even cryptocurrency.

How do investment funds work?

An investment fund is managed by a professional fund manager, who makes the investment decisions and controls what securities the fund should hold.

A fund is typically constructed to achieve specific investment goals. It may represent investments from a specific sector (like technology or healthcare), aim to deliver returns in line with a set level of risk, or select securities according to geography (e.g. emerging markets).

Alternatively, an investment fund may be indexed to track the performance of a particular financial market (e.g. the Standard and Poor’s Total Market Index, which is composed of US company shares).

Once all of the fund characteristics have been set, individuals can decide whether to invest based on their goals, appetite for risk and the fees they’re willing to pay for the fund portfolio management.

What are the benefits of investment funds?

An investment fund offers 3 main advantages for retail (non-professional) investors, compared to e.g. investing in stock from individual companies:

1. Build a diversified portfolio in an accessible way

2. Leave the asset management to a professional

3. Pay less in fees and trade transaction costs

With investment funds, you’re not putting all your eggs in one basket. The downside is that, in the same way that potential losses from your worst-performing assets are diluted, so too are any gains from the star performers. 

To try and achieve higher returns, some investors may include a small selection of the best-performing stocks in their portfolio, along with diversified funds. You can learn more about how to invest in stocks with Plum here.

What are the types of investment funds?

There are funds available to suit most investment strategies. Some of the most common types of funds include Exchange-Traded Funds (ETFs), Money Market Funds (MMFs), mutual funds and hedge funds.

Money Market Funds (MMFs)

MMFs are actually a type of short-term mutual fund and are widely considered to be a low-risk investment fund. They tend to focus on high-quality investments, like interest-generating government bonds.

Plum Interest is an MMF that tends to follow the Bank of England base rate so could deliver a better variable rate than one you might expect to receive in a traditional current account from a high-street bank.

Note: Plum is not a bank.

Mutual funds

Most investment funds are open-end mutual funds. This means they issue new shares as investors contribute money and retire them when they choose to sell some or all of their shares in the fund. Open-end mutual funds are only traded once per day, after the markets close.

Closed-end funds issue a fixed number of shares and trade on an exchange, based on investor supply and demand. Unlike open-end funds, closed-end funds can be bought or sold at any point during the trading day.

Exchange-traded funds (ETFs)

ETFs are considered a more modern approach to funds (versus open-end mutual funds) because they offer a more flexible approach to trading.

Unlike closed-end mutual funds, ETFs are priced throughout the trading day and can be bought or sold at any time.

Hedge Funds

Hedge funds tend to invest in securities that carry more risk, meaning they won’t normally make suitable investments for beginners.

They are only available to accredited investors, who are allowed to trade securities not registered with financial authorities (in doing so they accept the risks, without regulatory protection or risk warnings).

How can I invest in funds?

If you’re ready to start investing, the first thing to decide is how you’d like to select your securities and manage your portfolio. You’ll need to think about whether you prefer a mobile app, web portal, or traditional financial advisor.

The process of investing can be broken down into the following steps:

Step.1 Decide how much to invest

Step.2 Decide how frequently to invest

Step.3 Decide which types of investment

When choosing how to invest, you may wish to consider ease of use, variety of securities available and fees, amongst other things. 

If you’re starting out or not feeling confident about selecting funds, the Plum investment app has a range of simple Starter Funds. There are 3 options to choose from, based on your attitude to risk (Cautious, Balanced, and Bold).

Finally, always remember that when investing your capital is at risk. The value of your investments can go down as well as up, and you could get back less than you invested. Plum does not provide investment advice and individual investors should make their own decisions or seek independent advice. Fees and T&C apply.

Learn more about the range of investment funds offered by Plum.