Your coffee break investment plan - Day 7: Finding your way around funds

Funds are simply pooled investments, which allow individuals to invest their cash in a diversified range of stocks across a wide range of industries. But given there are thousands on offer, choosing one can feel like tiptoeing through a financial minefield. We look at the basics of what are available.

Passive vs active

In the broadest sense there are just two styles of to choose from - passive and active.

Passive funds, sometimes referred to as index trackers, are computer run portfolios that simply mirror or ‘track’ a particular stock market index, such as the FTSE 100 index of the UK’s biggest companies.

Their performance is dependent upon the fortunes of the market they are tracking. If it rises, the fund and the value of an investor’s stake will follow but equally the opposite happens if the market falls.

The bottom line is that investment returns from passive funds will echo, less costs, what the index has achieved. But they offer long-term investors cheap access to markets, as you can pay less than 0.1% in annual charges. They are growing in popularity too with sales hitting £5.4bn in 2015.

The more adventurous investor interested in the passive route may like to look at exchange-traded funds (ETFs). Again these are baskets of shares, and they robotically track a particular index. ETFs also offer a cheap way of accessing the market but they are listed on the stock exchange and are traded like stocks, so you have the flexibility of buying and selling them in real time.

Active investing on the other hand carries higher annual charges, typically nearer to 1% a year but with the heavier price tag comes added service. An active portfolio has a fund manager in the driving seat, buying and selling stocks on your behalf and what they want to achieve are market-beating returns.

The main advantage of the active route is if a manager believes a particular sector or stock is about to fall, they can sell out and buy into something more attractive enabling them to protect their investors from potential losses.

Open vs closed-ended

It is worth bearing in mind fund structures too. Open-ended funds are sometimes referred to in City speak as unit trusts or open-ended investment companies (OEICs), in that when you buy units, the portfolio provider simply issues a new batch.  Open-ended funds can be active or passive.

Closed-ended funds, also known as investment trusts, are a slightly different beast though their end-goal, to deliver market-beating returns, is the same. They are closed ended, because they issue a limited number of shares, are structured as a limited company and listed on the stock exchange.

As investment trusts are traded as stocks, their price can fluctuate, depending on investor demand. If a trust is popular its shares can move up to trade at a premium. In other words, they can exchange hands for a greater cost than their actual net worth or net asset value (NAV).

However, if the trust drops out of fashion shares can fall in value and can start trading at a discount to their NAV. This means for example, if a trust is trading at a 10% discount, you can snap-up £100 worth of assets, for £90.

If you missed them, make sure you read the first articles in this series.

Day 1: What is investing?

Day 2: What is the stock market?

Day 3: Setting investment goals

Day 4: The two enemies of investors: Inflation and tax 

Day 5: The importance of keeping charges low

Day 6: Having a range of eggs in your basket


Also watch Moneywise editor Moira O’Neill interview Andy Parsons from The Share Centre about why you should start investing.