What is an investment fund?
Investment funds (known as mutual funds in the US) are collective investment schemes, which pool your money with that of other investors to give you a stake in a ready-made portfolio.
Essentially, your money is spread across dozens or hundreds of different assets across the world, with the fund manager doing all the work.
The fund manager decides what to invest in and makes changes as time goes on; in exchange you pay them a fee. You make money when you sell your holdings in the fund and from dividends.
Here we explain how they work, and whether they’re right for you.
Please note: the content contained in this article is for information purposes only and does not constitute financial or investment advice.
Should I invest in a fund?
A fund provides an easy way to access many different shares, bonds and other assets and so adds balance to your portfolio, a crucial part of managing investment risk.
You could pick shares yourself and avoid paying the fund manager a fee. But that requires time, effort and knowledge in the areas you’re investing in. There will inevitably be sectors that you’re less knowledgeable about; here, a fund manager’s expertise can be worth paying for.
Do note that if you invest in a company through a fund, rather than directly buying its shares, you won’t be able to vote in an AGM – the fund manager will vote.
Investors with particular concerns, such as sustainability, should pick a fund manager with policies and a track record in this area (more on that below).
- Find out more: ethical investing explained
What are equity funds?
Equity funds invest in company shares.
Historically, equities have delivered higher returns than safer investments, such as savings accounts and bonds, and can act as the real driver for growth as part of a balanced investment portfolio.
Funds tend to focus on companies in a particular country (such as a UK equities fund), industry (eg healthcare), firms of a particular size (eg small cap funds) or a mix of these factors. A fund’s Key Investor Information Document (KIID) and Prospectus will detail how the fund would invest your money and how risky its strategy is.
Other than equities, funds can also invest in:
- bonds and gilts
- commodities, eg gold
- property
- other funds (known as multi-manager funds).
What are tracker and index funds?
Tracker funds track an ‘index’ – a group of companies, such as the FTSE 100 – by buying all or some of the investments in it. When an index rises, the value of your fund rises with it (after costs). Conversely, when the index falls, your investment in the fund falls with it, too.
These ‘passively managed’ funds are different from ‘actively managed’ funds, where the fund manager attempts to beat the performance of the market by hand-picking specific investments.
Though beating a market may sound more exciting than tracking it, only 35% of active equity funds were able to outperform the average passive fund in their sector over the last 10 years, according to AJ Bell’s Manager versus Machine July 2024 report.
This is in large part because tracker funds are far cheaper, sometimes costing as little as 0.1% a year (that’s £1 for every £1,000 invested), while active funds tend to charge more, such as 0.5% or more.
That difference might not seem huge, but over time those costs will add up. You’ll have to pay fees come rain or shine and an expensive fund will make a bad year even more painful.
Here’s how £1,000 in a fund costing 0.1% and a fund costing 1% would perform if both funds grew at a rate of 5% per year:
After five years, the cheaper 0.1% fund would be worth £1,275 and the more expensive 1% fund £1,214 – a gap of £61. After 10 years, the gap would be £154.
What makes a good tracker fund?
The best way to judge the performance of a passive investment fund is to look at its tracking error. This shows how far the fund’s performance deviates from the actual index it’s tracking.
Of course, no tracker fund will identically match an index, as an annual fee is levied on the funds. A tracking error of 0% would mean perfect replication. A tracking error that is just the cost of the fund is an indicator of an excellent passive investment.
Keep an eye on costs. With so many tracker funds tracking the same high-profile indices (such as the S&P 500), you may be able to find a cheaper fund doing the same job.
The problem with sustainable investing and tracker funds
One area where an actively managed fund could pay off is sustainable investing, otherwise known as ‘ESG’, ‘green’ or ethical investing
Such investors may want to exclude certain types of companies (such as fossil fuel extractors), or specifically target others (such as wind turbine manufacturers).
Many sustainable tracker funds take a long-established index then apply ESG criteria, which can leave you lining the pockets of the usual suspects, such as Amazon and Apple, rather than smaller firms driving the shift towards a green economy.
Active fund managers can be more picky, going beyond indices, and have more flexibility to remove holdings if they see fit, such as because a company has been involved in a controversy.
Another option is ‘active ETFs’, which are tracker funds that track a custom-made index of suitable firms.
What are unit trusts and Oeics?
Unit trusts and open-ended investment companies (Oeics) are two ways of structuring an investment fund.
Unit trust
The fund is split into units, and this is what you’ll buy. The fund manager creates units for new investors and cancels units for those selling out of the fund.
The creation of units can be unlimited, hence why the fund is ‘open-ended’. The price reflects the value of the fund on the day.
Oeics
Open-ended investment companies (Oeics) operate in a similar way to unit trusts except that the fund is actually run as a company.
It therefore creates and cancels shares rather than units when investors come in and go out of the fund, but they still directly reflect the value of the assets that your fund manager has invested in.
What are exchange-traded funds (ETFs)?
Exchange-traded funds are listed on a stock exchange, so you can buy and sell them at any time that the exchange is open.
ETFs can be more transparent, liquid (meaning you can move money in and out of them easily) and flexible than unit trusts and Oeics. Growing in popularity in recent years, they’ve enabled investors to cheaply access new markets, from beauty products to space exploration.
Though, these very specific themes leave you at risk of having your investments overly concentrated and vulnerable to industry-specific crises.
ETFs tend to be passively managed, and very cost-effective, though some are actively managed and hence more expensive.
Also, because ETFs are traded on the stock exchange, they may incur extra trading fees from investment platforms. If you buy and sell ETFs frequently, these fees can stack up.
How much do funds cost?
Against potential gains, you need to consider a number of costs:
- Ongoing charge figure (OCF) – an annual percentage of your investments you’ll need to pay to the fund manager, however the fund performs.
- Performance fees – usually levied by actively managed funds. These typically take 20% of everything above a certain level of performance.
- Trading fees and stamp duty reserve tax – paid when a fund buys or sells a share.
- Exit fees – charged by some funds should you decide to sell your investments.
- Platform fees – levied by the investment platform or financial adviser.
Fund fees can affect how much money you take away, so it’s important to see how a fund you might invest in compares to others that are similar.
How to buy and sell funds
The easiest way to buy funds is through an investment platform or an independent financial adviser (IFA).
An IFA can pick investments for you and provide advice on long-term investing strategies and reducing your tax bill.
An investment platform can prove far cheaper, though you’ll need to be comfortable picking your own investments. Many ‘do-it-yourself’ platforms have search tools, news and recommended fund lists to help you make your investment choices.
Do-it-for-me platforms have you fill in a questionnaire about your aims, attitude to risk and interests, before picking a range of funds for you. They tend to charge a little more than DIY platforms.
We’ve surveyed thousands of investors to find the best investment platforms. We also help you to compare investment platform fees and charges.
Buy within an Isa or Sipp
Buying your funds within a stocks and shares Isa, junior Isa, lifetime Isa or self-invested pension plan (Sipp) means you won’t pay dividend tax or capital gains tax.
Lifetime Isas also provide bonuses and Sipps provide tax relief.
Most investment platforms won’t charge extra for an Isa, although different platforms may have different funds/assets available to be held within an Isa.
- Find out more: Best stocks and shares Isas 2026
Which funds should beginners invest in?
Your attitude to risk and what you’re investing for should be the drivers of the funds you choose to invest in.
Funds are a great option for first-time investors as the fund manager can provide investing expertise. Multi-asset funds invest across a range of assets, often structured to appeal to investors with a particular risk appetite.
An ‘80% equities’ fund is higher risk (with potential for higher reward) than a 20% equities fund. This type of fund will be better suited to those with a higher risk tolerance and those who can leave their money invested for longer.