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What's a fund? I don't even know what an equity is

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Helen contacted us last month and spent a few paragraphs apologising for not even knowing what a fund is! Here’s a summary of our conversation with Helen.

It’s amazing how many people feel embarrassed about not understanding the stock markets. But why should they!? I don’t feel embarrassed for not knowing how a satellite works. Or how to fix my shower. If you don’t know what a fund is, it probably means you are out having fun instead of poring over performance tables!

Here are the basics to get you started. You don’t need to be an expert to make some sensible decisions so don’t let the pinstripe suits intimidate you!

I think of a fund like a big virtual basket. The fund manager’s job is to pick and choose the investments to stick into this fund. You can then buy a little piece of this fund – this small slice of the bigger fund is typically called a ‘unit’.

Another way of thinking about it is that it’s a bit like getting a personal shopper to fill your investment basket for you. Imagine telling someone what you wanted from a weekly shop. 4 meals for the kids, 2 adult dinners, stuff for the cat and some wine. And that person then filled the basket for you and delivered it to your door . That’s kind of what a fund manager does with investments. They fill the basket for you and deliver the basket to your door.

The fund manager and his team spend all day everyday starting at screens, doing geeky numbers and interviewing management teams from some of the world’s biggest companies. Their job is to try and predict what will happen to interest rates, which stocks will do well, when things are going to take a tumble, when to go with the herd and when to be different…..You employ them to do all of this so you don’t have to watch the Business News every day and try and work out what is going to happen to share prices or in global bond markets.

There are several different types of funds out there. In fact, there are about 90,000 of the damn things in Europe which is about 89,500 too many!

Here are the main ‘flavours’ of fund out there:

Bonds are the man your mother wanted you to marry. Shares are the bad girl your 19 year old self wanted to marry. Exciting. Volatile. And sometimes painful!

Owning a bond is kind of getting an IOU from a government or a company – you buy their bond and you’re lending them money. The dicier the prospect of getting your cash back, the more ‘interest’ they will pay you to compensate for the risk. So an Ecuadorian mining company bond would pay a gazillion times more than the relatively staid UK Government, for example. It’s a riskier loan so they’ll compensate you more for taking this extra risk. That’s the deal.

Shares – also known in poncey finance speak as ‘equities’ or ‘stocks’. If you own shares, you buy little pieces of the world’s biggest companies. And tie your fortunes to theirs.  As a rule of thumb, most ‘equity’ funds will have about 50 shares in them, although some managers have fewer, sticking to their convictions more about which shares are duds and which ones are winners.

Bond or shares? Many suggest diversification which means a sort-of Combo Meal of bonds and shares. Over the long-term bonds are seen as safer and less choppy than shares but many believe they will make you less over the long-run too.The point is that you buy some units in a fund, someone else picks the stocks or bonds for you, you don’t really have to worry about following the markets, and you also can spread the risk around 50 or so companies. If you buy just a single share, you’re very exposed to that one company’s fortunes and you have to remember to keep track of it and try and work out what’s ahead.

As a rule of thumb, if you’re a spring chicken and investing for ages in the future, you should probably look at mostly shares. If you’re getting on and likely to need your money soon, people typically prefer bonds because they’re less likely to crash as dramatically as shares, leaving you high and dry if you need to cash in your investments.

UK or global? Although there’s a documented tendency for us to stay close to home, most people suggest looking overseas too. Spread your bets. Each year, we see a few countries have their moment in the sun. ‘Emerging Markets’ are ‘spicy’, but have had a great year this year. People who bought a couple of years ago may not be so happy. When they’re good, they’re lovely and when they’re bad , they’re horrid. So pick your markets.

Of course investing in a fund is pricier than picking a bunch of investments yourself because you need to pay a fund manager.

Finally, I have most of my money in funds. I just don’t have the time or the discipline to track the stock market in enough detail. Markets might collapse or a share might blow up but if you’re doing the school run or a big presentation at work you can’t put that all on ice to deal with the issue. A fund manager can. The ongoing charge is typically about 0.75%, or £75 each year for every £10,000 invested. And then you have to pay administration, transaction and trading costs on top of that which vary but will typically add about 0.35% - 0.45% of costs. So that's up to about 1.2% a year all-in to hold a selection of funds. See which online investment services we rate in our Best Buys.

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