The Savvy Investor

Talk about stock market investment and you probably think of people buying or selling shares in a particular company. In reality, many investors want a simple way to spread their money across multiple companies, usually to mitigate the risk of one performing badly. The different ways of doing this can seem confusing, so let’s run through the basics.

ACTIVE FUNDS

The first big divide is between active and passive funds. An active fund usually involves a fund manager who takes money from clients and uses it to buy and sell shares. In effect they aim to use their judgement to pick winners, avoid losers, and outperform the market as a whole. They are usually paid a management fee calculated as a percentage of the investment. Naturally performance varies and it can be difficult to compare investment funds based on past performance. It’s possible the fund or its manager either had a lucky streak or has carefully selected the period for which they are boasting of their performance. Fund managers won’t always concentrate solely on making the biggest return. Instead they’ll follow particular guidelines for the fund. For example, some might aim to balance risk and return or even prefer the ‘safest’ investments. A fund might also specialise in buying shares in environmentally responsible or ethical companies.

PASSIVE FUNDS

A passive fund, sometimes called a tracker fund, doesn’t try to pick the best shares. Instead it will either buy shares from all the companies in a particular stock market or buy a representative sample. Either way, the aim is that the overall performance will very closely mirror that of an entire market or a stock market index (such as the FTSE 100). The passive approach is unlikely to bring the spectacularly high returns that come from picking the most successful firms. At the same time, it’s less likely to lead to dramatic losses from picking shares in companies that slump or even go out of business. It’s more of a slow and steady approach, particularly if you have the time to ride out short-term swings in the market as a whole.

UNIT TRUSTS

The way you put your money into investment funds and what you are technically buying also varies. Perhaps the best known is the unit trust, where multiple investors pool their money for the fund manager to invest. The fund owns a collection of shares and then each investor owns a unit of the entire fund. When you come to sell your unit, the money you get back depends on the overall value of the shares the fund owns.

OEIC

Another option is the open-ended investment

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company (OEIC). This is a fund that operates as a business and has its own shares. Rather than own a unit of the fund, you technically buy and sell shares in the company itself in the same way as you would with a normal publicly traded business. However, you’ll normally have to pay a fee (to cover the fund management) when you buy shares in an OEIC and you may have to pay an exit fee when you sell shares.

EXCHANGE TRADED FUND

You may also encounter an Exchange Traded Fund. It’s similar in operation to an OEIC, though you can usually buy or sell an ETF instantly and know the price exactly. When you buy or sell an OEIC your order isn’t processed until the next available valuation point, when the fund calculates the value of its various investments. This can mean a little less certainty. Another difference is that an OEIC is usually actively managed, with a manager choosing the investments. An Exchange Traded Fund is a passive fund that aims to reflect a particular stock exchange.

TAX IMPLICATIONS

In principle, any profits you make from investment funds are treated as taxable income, subject to an annual dividend allowance. However, you can get tax benefits from holding the fund in a stocks and shares ISA in the same way as trading a single company’s shares. Either way, always seek professional advice when investing to make sure you comply with tax laws and take advantage of available allowances.

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