A fund is a collection of money from many investors. This pool of money can be invested in stocks, bonds, in a specific sector, or a combination of them. The main advantage of investing in a fund is the diversification it provides to us by spreading our risk. So, a fund can invest in places where an individual investor may not be able to.
Depending on how much money you invest in the fund, you’ll get a share in the fund. In investing theory, we call them units. So, the value of your units can go up or down based on the performance of the fund.
Funds can be actively managed or passively managed. In my next post, we will learn about these in more detail.
Where do funds invest?
A fund can invest in a variety of asset classes or in specific assets like only stocks or only bonds. The name of the fund usually states its purpose.
Equity funds, as the name suggests, invest in stocks, while fixed-income funds will invest in bonds – both corporate and government bonds. Some balanced funds invest in both stocks and bonds together.
Growth funds only want to invest in growth companies because they see a high potential for growth in these companies. Most technology companies are growth companies. This is the fast and furious approach to investing, where the fund manager will try to find companies with growing revenue, cash flows, and profits. These companies generally tend to be new companies, with a few exceptions.
On the contrary, Value funds invest in stocks of undervalued companies that pay high dividends. This approach is the slow and steady approach. Value fund tends to invest in companies that are well-established and mature. They usually offer investors a steady stream of income.
Funds could also be sector-specific, like energy funds that only invest in energy companies.
Some funds only invest in large-cap companies like those in S&P 500 index. So, when you invest in those index funds you are investing in many large-cap companies without bearing the risk of owning stocks of individual companies.
Investing in a fund that mimics a broad-based index will save you a lot of money. Also, most large-cap companies’ stock price trade at a very high value, and it will require a lot of money to buy several different stocks of different companies. Something that a lot of us can’t do.
You don’t need a lot of money to invest in a fund!
Did I tell you that you don’t need a lot of money to invest in a fund? Most funds like ETFs and index funds do not have minimum requirements.
So, hopefully, you got an idea about the purpose of the funds.
There are mainly four types of funds you will most often hear about
- Mutual funds (actively managed by professionals)
- Exchange-traded funds or ETFs (similar to mutual funds and stocks, could be active or passively managed)
- Index funds (passively managed, my favorite)
- Hedge funds (need a lot of money to invest in these, so many of us don’t qualify)
I will cover each of these in detail in my next post. So stay tuned if you want to know the advantages and disadvantages of each of these four and which one could be a better choice for a new investor.
