If you’re exploring the world of investing for the first time, you may have considered buying investment funds. And guess what? Funds can be a great addition to your investment portfolio. It’s just there are so many different types, styles, and strategies to choose from.

That’s why I’ve written this beginner’s guide, to help you navigate the exciting yet sometimes complex world of investment funds.

I’m going to walk you through everything you need to know about selecting, buying, and managing your first investment fund in the UK. So let’s get started.

Section 1: Understanding Investment Funds

If you’re new to the world of investing, the term ‘investment fund’ might not be familiar, but hopefully it’s simpler than it sounds. An investment fund is essentially a pool of money collected from multiple investors. This pool is then used to buy a diversified portfolio of assets, such as stocks, bonds, or property. The idea is to spread the risk across a range of investments rather than buying, say, one stock.

In the UK, when we talk about investment funds, we’re broadly referring to two main types: open-ended funds and investment trusts. More on the differences between these types of funds in the following section.

Investment funds are managed by professionals who decide where to invest the money. These managers aim to provide a return to the investors (that’s you!) either through income, such as dividends, or through growth in the value of the assets.

One key concept to understand is ‘net asset value’ (NAV). This is the total value of the fund’s assets minus its liabilities. The NAV is an important concept when it comes to investment funds and we’ll cover this in Section 2.

It’s important to remember that all investments carry risk, and the value of your investment can go down as well as up. However, the diversified nature of investment funds can help spread and potentially reduce that risk compared to investing directly in a single stock or bond.

In summary so far, investment funds offer a convenient way to access a broad range of investments, managed by professionals, making them an attractive option for many beginner investors in the UK. In our next section, we’ll explore the different types of funds you can choose from.

Section 2: Types of Investment Funds

We’re going to get into the detail of different types of investment funds now. It’s good to understand what’s available in the UK so that you can build a well-diversified portfolio. Let’s break down the key types.

Open-Ended Funds

We touched on these funds before. They are what many refer to globally as mutual funds, but in the UK, they’re known as open-ended funds.

They work by pooling money from investors to buy a portfolio of assets. The key feature is their flexibility in share issuance; the fund grows in size, or number of shares, when more investors buy in, and the number of shares reduces when investors sell.

Open-ended funds are priced based on their NAV, which changes daily with the fund’s asset values such as when stock prices change.

Investment Trusts

Unique to the UK, investment trusts are a type of public limited company listed on the London Stock Exchange. They operate similarly to open-ended funds in pooling investor money, but they differ in several key ways.

Firstly, they have a fixed number of shares in circulation, and they are traded like stocks. This means their price can be above (at a premium) or below (at a discount) the NAV.

Secondly, it can be more common for investment trusts to borrow money to invest, known as ‘gearing,’ which potentially amplifies gains (and losses).

Exchange-Traded Funds (ETFs)

ETFs combine features of both investment trusts and open-ended funds.

They trade on stock exchanges with prices varying throughout the day, just like an investment trust. But ETFs always trade at NAV like an open-ended fund due to the role of an Authorised Participant (AP). For a more detailed review of APs check out this post from BlackRock.

Index Funds

I’m going to mention a couple of fund strategies now, starting with index funds.

These funds aim to track the performance of a specific market index, such as the FTSE 100. They’re a form of passive investing, with lower management fees, as they simply replicate the index’s composition rather than actively selecting stocks to try and beat the market’s performance.

Index funds are ideal for investors looking for broad market exposure and who believe in the market’s long-term growth.

Specialist & Thematic Funds

Next up are specialist, or thematic funds.

These funds focus on specific sectors (like technology or healthcare) or follow particular themes (like sustainable investing). They offer a way to invest in areas you’re passionate about or foresee high growth, but they can be riskier due to their focus on a narrower market segment.

Each type of investment fund has its own characteristics, benefits, and risks. Open-ended funds and investment trusts are popular choices in the UK, offering different approaches to portfolio management and investment strategies.

When choosing a fund, consider factors like your investment goals, risk tolerance, time horizon, and interest in specific market sectors. Understanding the different types of funds will allow you to make informed decisions that align with your personal financial journey.

Next up, we’ll discss some of the benefits of adding investment funds to your portfolio.

Section 3: Benefits of Investing in Funds

Now that you have a basic understanding of what investment funds are, let’s delve into why they are often a go-to choice for beginner investors in the UK. Here are some of the key benefits that make investment funds an attractive option:

• Diversification: One of the golden rules of investing is not to put all your eggs in one basket. Investment funds inherently follow this rule. By pooling money from various investors, these funds can invest in a wide array of assets – from shares in different companies to bonds and real estate. This diversification reduces the risk of your investment significantly, as the impact of any single asset performing poorly is lessened.
  
  

• Professional Management: When you invest in a fund, you’re not just buying into a portfolio of assets; you’re also gaining access to the expertise of professional fund managers. These experts are responsible for making decisions about which assets to buy and sell, and when to do so. For beginners who may not have the time or expertise to manage investments actively, this is a huge advantage.
  
  

• Accessibility: Investment funds make it possible for individual investors to access a range of assets that might otherwise be out of reach. For example, UK-based investors can’t buy Indian stocks directly, but can do through a fund.
  
  

• Liquidity: Open-ended funds, in particular, typically offer good liquidity. This means you can generally buy and sell your shares in the fund relatively easily. This is handy if you need to access your money – although it’s always best to view investing as a long-term process.
  
  

• Cost-Effective: While there are fees associated with investment funds, these can be lower than if you were to try and create a diversified portfolio yourself. This is because funds operate on an economy of scale – they’re buying and selling large amounts of assets, which can reduce transaction costs. It does depend on the type of fund you choose, though.
  
  

• Simplicity: For a beginner investor, navigating the stock market can be overwhelming. Investment funds offer a simpler way to get started. You choose a fund that aligns with your goals and risk tolerance, and the fund manager takes care of the rest.
  
  

• Regular Savings Plans: Many funds offer the option to invest small, regular amounts – a great feature for those who want to build their investment gradually. This can be more manageable for beginners than making large, one-off investments.

Investment funds can offer a balanced, professionally managed, and accessible starting point for your investment journey. They provide a straightforward way to grow your money while mitigating some of the risks associated with direct stock market investment.

In the next section, we’ll explore how you would go about choosing the right investment fund for your portfolio.

Section 4: How to Choose the Right Fund for You

Choosing the right investment fund may feel like finding a needle in a haystack. With so many options, how do you pick the one that’s right for you? Here are some key factors to consider that will help guide your decision:

• Understand Your Risk Tolerance: First things first, how much risk are you comfortable taking? Different funds come with different levels of risk. For instance, equity-based funds generally offer higher potential returns but also higher risks compared to bond funds. Knowing your risk tolerance will help you narrow down the type of fund that suits you best.
  
  

• Define Your Investment Goals: Are you investing for long-term growth, like retirement, or for a short-term goal, like saving for a car? Your investment horizon will influence the type of fund you should consider. Longer-term goals may allow you to weather the ups and downs of higher-risk funds, whereas short-term goals might call for more conservative investments.
  
  

• Consider Costs: Every fund has associated costs, including management fees, transaction fees, and potentially others. These can eat into your returns over time, so it’s essential to understand and compare the costs of different funds. Look for the Ongoing Charges Figure (OCF) or Total Expense Ratio (TER) when comparing funds.
  
  

• Research Fund Performance: While past performance is not an indicator of future results, it can give you an idea of how the fund has managed under various market conditions. I always look at long-term performance over several years (five or more), rather than short-term periods.
  
  

• Assess Fund Management: Investigate the fund manager’s track record and investment philosophy. Are they experienced? Do their investment strategies and philosophies align with your values and goals? This is particularly important for actively managed funds.
  
  

• Diversification: Ensure that the fund diversifies its investments in relation to its stated strategy. This can help mitigate risk. If you’re looking at specialist or thematic funds, consider how they fit into your wider investment portfolio in terms of diversification.
  
  

• Check Accessibility and Liquidity: Consider how easy it is to buy and sell shares in the fund. Open-ended funds usually offer high liquidity, meaning you can buy and sell your shares at any time. Investment trusts, traded like stocks, may offer more or less liquidity depending on their market demand.
  
  

• Read the Fund Prospectus: This might not be the most exciting part, but it can be useful. The prospectus provides detailed information about the fund’s objectives, strategies, risks, and costs. It’s a valuable source of information to understand what you’re investing in.
  
  

• Align with Your Values: If you have strong beliefs about ethical or sustainable investing, look for funds that align with these values. There are many funds now that focus on environmental, social, and governance (ESG) criteria.

Remember, there’s no one-size-fits-all answer when it comes to choosing an investment fund. It’s about finding the right fit for your individual circumstances and goals. Take your time, do your research, and consider professional advice if needed.

In the next section, we’ll walk through the practical steps of buying your first investment fund in the UK.

Section 5: Steps to Buying Your First Investment Fund

Now that you’ve got a handle on choosing the right fund, it’s time to take the next step and make your first investment. Here’s a step-by-step guide to help you through the process:

• Set Up an Investment Account: First, you’ll need an account to buy and hold your investments. This could be a Stocks and Shares ISA, a general investment account, or a self-invested personal pension (SIPP), depending on your goals. Each account type has different tax implications and rules, so choose the one that best suits your needs.
  
  

• Choose a Platform: Next, select a platform or broker to buy your fund through. There are many online platforms available in the UK, each with different fees and services. Compare their charges, fund availability, customer service, and user interface to find the best fit for you.
  
  

• Fund Your Account: Once your account is set up, you’ll need to deposit money into it. Most platforms allow you to transfer money from your bank account. Decide how much you want to invest – remember, it may be wise to start small and increase your investment over time.
  
  

• Research and Select Your Fund: Utilise the knowledge from the previous sections to choose a fund that aligns with your goals, risk tolerance, and values. Use the platform’s research tools to help you make an informed decision. Also check out these example portfolios for some ideas.
  
  

• Place Your Order: When you’re ready, place an order for the fund. You can usually choose between making a lump sum investment or setting up regular contributions. If you’re unsure about timing, regular contributions can help smooth out market ups and downs.
  
  

• Monitor Your Investment: Once your investment is made, it’s important to keep an eye on it. However, try not to obsess over short-term fluctuations. It’s normal for investments to go up and down, and frequent trading can rack up costs.
  
  

• Review Regularly: Set a schedule to review your investment, such as annually. This is the time to check its performance, reassess your goals, and adjust your holdings if necessary. It’s also a good opportunity to invest more if you can.
  
  

• Stay Informed: Keep up to date with the financial news and how it might affect your investments. However, try to avoid knee-jerk reactions to short-term market movements.
  
  

• Seek Advice When Needed: If you’re ever unsure, don’t hesitate to consult a financial advisor. They can provide personalised advice based on your individual circumstances.

Buying your first investment fund is an exciting step towards building your financial future. Remember, investing is a marathon, not a sprint, and patience is key.

In the next section, we’ll discuss how to manage your investments, ensuring it continues to meet your financial goals.

Section 6: Managing Your Investments

Congratulations on purchasing your first investment fund! But the journey doesn’t end here. Effective management of your investment portfolio is crucial for long-term success.

So below, I’ve outlined some key ideas to be aware of as you turn to portfolio management.

Keep an Eye on Performance, But Don’t Obsess

It’s natural to be curious about how your investment is doing. Most platforms provide tools to track the performance of your fund. However, it’s important not to get too caught up in daily fluctuations. Investments are typically for the long-term, and patience is key.

Understanding Volatility

The value of your investment will go up and down – that’s the nature of financial markets. What matters is the overall trend over years, not days or months. Learning to stay calm during market dips is an important part of being an investor.

Rebalancing Your Portfolio

Over time, the original allocation of your investments can shift due to differing performance of assets. It’s a good idea to check periodically (like once a year) and rebalance if necessary to maintain your desired level of risk and diversification. However, I’m generally against over-trading and do like to let my winners run. As one of my investing inspirations once said:

Selling your winners and holding losers is like cutting the flowers and watering the weeds.

Peter Lynch

Consider Drip-Feeding Your Investment

If you’re adding to your investment over time, consider a strategy called ‘pound-cost averaging.’ This involves investing a fixed amount regularly, which can help smooth out the highs and lows of the market. It can be a good way for some people to build a disciplined approach to saving and investing.

Stay Informed About Your Fund

Keep abreast of any news or changes related to your investment fund. This could include changes in fund management, strategy, or performance. Your investment platform and financial news sources can be good resources. Check out Trustnet (as well as this blog!) too.

Review Your Investment Goals

As your life circumstances change, so might your financial goals and risk tolerance. Regularly review your investment to ensure it still aligns with your current needs and future plans. I do this formally at least once a year.

Resist the Urge to Time the Market

Trying to buy low and sell high might sound appealing, but it’s extremely difficult to do consistently. For most investors, especially beginners, it’s often more effective to invest regularly and stay invested over the long term (see ‘pound-cost averaging’ above).

Know When to Seek Advice

If you’re unsure about any aspect of your investment or if there are significant changes in your financial situation, it might be wise to consult a financial advisor. They can provide guidance tailored to your specific needs.

Investment fund management is not just about monitoring performance; it’s also about ensuring that your investment continues to align with your evolving financial goals and risk tolerance.

In the next section, I’ll cover some common pitfalls to avoid as a beginner investor.

Section 7: Common Pitfalls to Avoid

Investing can be a rewarding journey, but it’s not without its bumps along the way. As a beginner, being aware of common pitfalls can help you navigate this journey more smoothly.

Here are some typical missteps to avoid.

Not Doing Enough Research

Jumping into an investment without sufficient research is like setting off on a road trip without Google Maps. Take the time to understand the fund’s strategy, risks, and fees. Don’t just go by past performance or follow the crowd. Here are some ideas to get you started.

Overreacting to Short-Term Market Movements

The market will have its ups and downs, and it’s easy to panic when you see values drop. Remember, investing is a long-term game. Avoid making hasty decisions based on short-term market movements.

It’s been shown that investors can lose money even in the best performing funds. Why? Because they pile in at the top of a good run, the fund underperforms for a short while, and the same investors sell at a loss. Guess what happens next? The fund rises. Try and avoid this short-termism.

Putting All Your Eggs in One Basket

Diversification is key in investing. Don’t put all your money into one fund or asset class. A well-diversified portfolio can help spread risk. Check out the efficient frontier to start building an asset allocation to suit your risk level.

Ignoring Costs

Fees and costs can eat into your returns over time. Always be aware of the charges associated with any fund, including transaction fees, annual management fees, and any other costs.

Following the Herd

Just because everyone is investing in a particular fund or sector doesn’t mean it’s right for you. Your investment choices should be based on your own goals, risk tolerance, and research. Remember that short-termism example above.

Following the heard is akin to Fear Of Missing Out, and FOMO is a terrible investment strategy over the long term.

Underestimating the Impact of Taxes

Consider the tax implications of your investments. Different types of investment accounts have different tax treatments, which can affect your returns. Us investors in the UK have a huge advantage as we can use not only our pension, but our ISA, which shelters all capital gains and income from tax. Pound-cost averaging into an ISA can be a great combination.

Being Unrealistic About Returns

It’s important to have realistic expectations about potential returns. High returns usually come with high risks. Be wary of any investment that promises high returns with little or no risk. Have a look at different asset classes to get a better idea of their risk and return profiles.

Not Learning from Mistakes

Every investor makes mistakes. What’s important is to learn from them. Reflect on what went wrong and how you can avoid similar mistakes in the future.

A key thing to remember is you won’t get every investment right, and that’s ok. Even the pros get it wrong. But it’s how you manage risk that counts the most over the long term.

Delaying Investment Decisions

Procrastination can be a significant barrier. The sooner you start investing, the more you can benefit from compound growth.

By avoiding these common pitfalls, you’ll be better positioned to make informed decisions and achieve your investment goals.

In the next section, I’ll conclude this guide with a summary and further resources to continue your investment journey.

Section 8: Conclusion and Further Resources

Congratulations! You’ve navigated through the basics of buying and managing investment funds in the UK.

By now, you should have a solid foundation to start buying investment funds. Let’s quickly recap what we’ve covered and look at some resources for further learning.

Recap of Key Points

• Understanding Investment Funds: Investment funds pool money from many investors to buy a diversified portfolio, managed by professionals.
• Benefits of Investing in Funds: Funds offer diversification, professional management, and accessibility, among other benefits.
• Types of Investment Funds: We explored open-ended funds, investment trusts, index funds, ETFs, and specialist & thematic funds.
• Choosing the Right Fund: Consider your risk tolerance, investment goals, costs, fund performance, and management when selecting a fund.
• Buying Your First Investment Fund: Set up an investment account, choose a platform, fund your account, research, and buy your chosen fund.
• Managing Your Investment: Monitor performance, understand market volatility, rebalance your portfolio, and review your investment goals regularly.
• Common Pitfalls to Avoid: Avoid not doing enough research, overreacting to market movements, ignoring costs, and FOMO.

Final Words of Advice

Investing is a journey, not a one-time event. It requires patience, continuous learning, and the ability to adapt to changing circumstances. Remember, it’s ok to start small and gradually increase your investments as you gain more confidence and understanding. Most importantly, always invest within your means and be mindful of the risks involved.

I hope this guide has helped you to start considering investment funds for your portfolio. If you have any questions or need further guidance, don’t hesitate to reach out or seek professional advice.