You can invest in funds through several channels. The simplest way is to contact the provider of the fund you want to buy, by telephone, on the internet, or by returning the tear-off sheets from advertisements published in the financial pages of the newspapers.
However, most people should take advice before investing. There are two ways to do that - you can either talk to a tied salesman for one of the fund providers, or you can discuss your investment plans with an independent financial adviser.
The third way to invest is through a funds supermarket or discount broker. A large number of these can be accessed via the internet (try entering "funds supermarkets" into a search engine).
Both discount brokers and IFAs use funds supermarkets to locate and purchase funds, but going direct to the supermarket may not save you much money. This is because supermarkets generally rebate only part of the upfront fee, and none of the annual management fees you will be charged. Buying direct from the company or through a tied salesman will also incur full upfront and annual fees, unless you are taking advantage of a special offer.
Investors can usually decide to invest either a lump sum or smaller amounts in monthly instalments. Most funds will have a minimum lump sum investment of £500 or more, with a minimum monthly instalment of £50. Some will have higher thresholds for both lump sums and instalments, but it is possible to invest in funds for as little as £20 a month.
If you have available cash, you will benefit from investing in a lump sum if markets move in a favourable direction because your money will have been invested at the lowest possible average price - that is, the price of the fund's units or shares on the day you invested. On the other hand, of course, your losses will be greater if the market moves against you.
For this reason, there is much to be said for a regular investment plan. This stops investors trying to anticipate the market, which few have the skills or experience to do successfully, and ensures that they continue to build up their investment in the fund regardless of short-term swings in valuation.
Regular investment, also known as drip-feeding, can also reduce investment risk by smoothing the impact of swings in prices. This effect, known as pound cost averaging, occurs because the same amount of cash will buy more shares if prices have fallen since the last regular investment, increasing the potential gain when prices start rising.
Many investors combine the two approaches by investing a lump sum at the beginning and then undertaking to make regular investments in addition.
How much do funds cost?
Investors in funds will usually have to pay an upfront charge, typically 5 per cent of the amount being invested, plus an annual management charge, which will probably be between 0.75 per cent to 1.5 per cent of the value of the fund for actively managed funds, and between 0.5 per cent and 0.75 per cent for index tracking funds. Charges levied by some funds may be above or below this central range.
Investors looking for low cost funds should watch out for CAT marked funds. This is a government scheme that identifies funds adhering to rules on charges, access and terms. These funds must offer Individual Savings Account wrappers with an annual management fee of no more than 1 per cent of the fund value.
All or most of the upfront charge will go to the financial adviser or sales person who recommends or sells the fund. The remainder is kept by the fund. A few fund groups offer "no load" funds, which levy an exit charge rather than an upfront charge. This is imposed when an investor sells shares or units in a fund, and usually falls over time as an incentive to investors to keep their holdings.
The annual charge covers the cost of running the fund, including things like administration, brokerage costs (what the fund pays to buy and sell shares) and management fees (covering payments to the specialists who decide and executive the fund's investment strategy).
Actively managed funds are usually more expensive because investors are paying the costs of extensive research into companies and remuneration for specialist stock-pickers. Passive investments should be cheaper, although they still have to be administered and cover the costs of buying and selling stocks to remain in line with the composition of the index it is tracking.
These costs are not trivial for small investors, and they can amount to substantial sums for those with large holdings. However, it is worth remembering that achieving a similar level of portfolio diversification by buying individual shares and bonds would be much more expensive because the investor would have to bear the full cost of brokerage fees, and might have to purchase shares in large blocks because of restrictions on trades in small parcels. Only the very wealthy are likely to have sufficient assets to follow such an individual strategy.
Morningstar, the mutual funds research group, estimates that a private investor in a relatively concentrated fund with holdings in about 40 companies would need to invest about £40,000 in direct shareholdings to replicate the diversification benefits that can be achieved within the fund for a few hundred pounds www.morningstar.co.uk.
Like individual shares and bonds, investments in funds can be held within Individual Savings Accounts, though only within investment limits set by the Treasury. Holding funds within an Isa boosts returns because most income and all capital gains are exempt from tax. Higher rate taxpayers benefit most.
