One of the basic rules of investing is to spread your money so you reduce the risk. The best way to do this is to invest in funds. The question is, which fund or funds should you invest in? Here’s a guide to the different types of investment funds.
Different types of investment funds
There are several different types of investment fund. It’s worth understanding how they differ if you’re new to investing. Jargon alert – in this article I’m going to talk about the different types of fund based on what they invest in or who runs them, not on the structure of the fund itself.
SAVVY TIP: There are various types of fund, such as unit trust, investment trust and OIEC, which differ because of how they are structured, rather than by what they invest in. For example, there are investment trusts, which I’ve explained in my Beginner’s guide to investment trusts and exchange traded funds, which you can read about in my article called Should you invest in exchange traded funds or are they too risky?
Growth funds can invest in a wide range of companies. As the name suggests, the idea is that the value of the fund grows over time. Growth funds often invest in companies that reinvest their profits in growing the business rather than paying them out to shareholders. These tend to be younger companies, but I’m not necessarily talking about very young companies or start ups – these can be companies that have been trading for a number of years.
SAVVY TIP: Growth funds can also invest in older companies that pay out a percentage of their profits as dividends. All they do is reinvest the dividends back into the funds, rather than paying it out as income (see below).
As a general rule, income funds invest in larger, older companies that are less likely to experience high growth. Instead, these companies pay out a dividend to their shareholders. If you invest in an income fund you can either receive these as regular payments or reinvest the income to increase the value of your fund.
Income funds aren’t restricted to investing in shares alone. They can invest in bonds as well. These are essentially IOUs for company loans.
As the name suggests, balanced funds sort of strike a balance between income and growth funds. They can invest in companies that are likely to grow and in income producing companies (ones that pay a dividend). Like income funds, they can invest in bonds as well as companies.
Multi-manager funds invest in funds run by a range of fund managers. There are two types of multi-manager funds: funds of funds and managers of managers (phew!).
In a fund of funds, you invest in an investment fund which itself invests in a range of other funds. In a manager of manager fund, there may be several specialist managers appointed to invest.
SAVVY TIP: In these ‘manager of manager’ funds, the investment managers don’t work together in the same way that a fund management team would if it was employed by an asset management company, instead they focus on their own area of expertise and the instructions they’ve been given as to what they’re supposed to achieve and how much risk they can take.
The advantage of a multi-manager fund is that you get exposure to a wider range of expertise and investment styles than if you invested in a straightforward fund. The disadvantage can be that charges may be higher.
SAVVY TIP: If a fund of funds only invests in funds managed by the same investment company, it’s called ‘fettered’. If it can invest in funds run by other fund managers, it’s called ‘unfettered’.
Multi-asset funds invest in a wider range of assets than some traditional funds may do. So, for example, they may invest in property, commodities (such as gold or oil) and company or government bonds as well as shares. A number of funds that aren’t branded as multi asset may do a similar thing.
Tracker or passive funds
These funds track a stock market index. That means they invest in companies that make up a stock market index or that represent the index. This could be the FTSE 100 index or FTSE All Share index in the UK, or the Dow Jones Industrial Average in the United States.
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