A Breakdown of Investment Funds
There is no I in team, right?
You might be surprised that there is a financial asset that is based on the same principle: investment funds.
An investment fund is a pool of capital (money) that belongs to a group of investors, each of which contributed to a portion of the total fund. The fund is then used to buy certain securities — tradable financial assets — such as stocks or bonds. After a security is purchased, each investor part of the fund receives ownership of their own portion of shares.
With an investment fund, there are a wide variety of assets to invest in, from stocks to futures. However, when an investor joins a fund, they have no influence on what the fund invests in. Rather, they choose to invest in a fund that aligns with their personal goals such as the specific security they wish to invest in, their risk tolerance, and desired selling price and time period. For example, an investor looking to invest in low-risk assets and willing to wait long-term to make profit would most likely join a fund that invests in bonds.
Well, if a fund’s decisions aren’t influenced by the investors part of the fund, who directs the fund’s actions?
Each fund has a fund manager that controls different aspects of the fund, such as what securities it should invest in, how long the securities should be held, and how much of a particular security should be bought or sold. They essentially are responsible for creating goals for a specific fund and devising a strategy to achieve those goals. To do this, they must do in-depth research on potential companies and their trends as well as the economy. A fund manager also oversees the fund’s portfolio, the collection of securities the fund has invested in.
Why invest in a fund instead of going solo? Some of the benefits of investing in a fund include a greater selection of investment opportunities, lower fees, and expert management from the fund managers and investment analysts involved in the fund. Additionally, because investors pool their resources together when investing in a fund, they also reduce the risk due to the diversity of the investment portfolio of the fund.
Imagine you are an inexperienced individual who wants to make a profit through investing but doesn’t have time to learn how due to a full-time job or some other obligation. Investing in a fund allows you to allocate a portion of your capital to knowledgeable individuals who can use their experience to help you make a profit. That’s the basic reason behind why funds can be beneficial for the general population.
Within the realm of investment funds, there exists different types of funds, each with their own specific characteristics. Some of the most prevalent funds are mutual funds, exchange-traded funds (ETFs), and hedge funds.
A mutual fund is essentially the same type of fund I described above — it allows investors to group their capital to invest in a variety of securities. A mutual fund’s portfolio aligns with the specific objectives of the fund, and is managed by the fund managers and financial analysts part of the fund. Additionally, because each individual investor part of the mutual fund is granted access to the portfolios containing the different stocks, bonds, and other securities the fund is invested in, each investor also participates in the fund’s gains or losses. It’s important to note that mutual funds are not traded on markets like the stock market the same stocks or other securities are.
ETFs are very similar to mutual funds in the way they operate. The main difference is that ETFs can be bought and sold on different markets, just like a stock of a company. This is why they are called exchange-traded funds — because they can be continuously bought and sold on different exchanges throughout the day. An ETF can consist of assets in a specific industry or sector, such as agriculture, or it can contain as many as thousands of stocks from a variety of industries.
Hedge funds are another type of fund that are usually considered higher risk investments. The reason for this is because the managers of hedge funds rely on methods such as buying with borrowed money or buying assets which only a few people are knowledgeable about. Using borrowed money can cause minor losses to result in tremendous debts. They also charge higher fees than traditional investment funds.
As you can see, each type of fund is different but they all are based on the same basic principle of pooling money together to reduce risk and have more investment options.
