There are many different types of investment funds available and the laws governing various investment funds varies from one jurisdiction to another. It is therefore important to be vigilant before investing money in an investment fund.
When you invest in an investment fund, you are in essence investing together with other people. The money from the investors are pooled and used for investments. One of the upsides of investing in an investment fund instead of investing directly in stocks, options, etc is that even if you only have a small amount of money to invest, you can get a nice risk diversification. Of course, some investment funds aren’t very diverse when it comes to their investments so you can’t take a high degree of diversification for granted. To achieve a high degree of diversification, an investment fund should ideally not just invest in different asset classes but also spread its investment over various market sectors.
The assets held by the investment fund are not your assets. They are not held in your name. If you were to go out an purchase a share in Apple Inc directly, you would be one of many owners of Apple Inc and you would have a right to attend general meetings and vote. If you put money into an investment fund and the investment fund buys shares in Apple Inc, you do not gain any such rights.
Many people invest in investment funds simply because they don’t want to put much time and effort into managing their investment. They don’t want to day trade, they don’t want to keep an eye on the economic developments in various market sectors, and so on. When you invest in an investment fund, you only have to make a few decisions:
- Which investment fund to invest in.
- How much to invest.
The rest is handled by one or several professional investment managers. Of course, these managers need to be payed somehow, which means that you – the investor – is in one way or another paying them to handle your money. Before you commit to any investment fund, always check how the investment managers are paid. Is there some sort of variable involved (e.g. performance based renumeration) or will the managers get a fixed percentage each year? And are you willing to foot the bill for this? Even a rather low fee can erode your investment over time, especially when you consider how much that money could have grown if you had kept it. If you are paying $1 today, you aren’t just losing $1 – you are losing the money that your $1 could have earned you in the future.
Last but not least – one benefit with investment funds is that since it’s a big pool of money, the investment fund can often get the transaction costs down considerably compared to what it would cost for each individual investor to go out and buy his or her own stocks, warrants, bonds, etc. So, when you are pondering if you really want to pay a professional investment manager you should 00 take into account the transaction costs you will need to pay if you elect to manage your money yourself.
Open-ended investment fund vs. close-ended investment fund
Open-ended investment fund
An open-ended investment fund is divided into shares/units and is constantly open for new investments. If you buy into the fund, new shares/units are created and you become the owner of these shares/units. The price you pay for a share/unit is based on the net asset value of the investment fund.
Close-ended investment fund
The main idea of a close-ended investment fund is that new shares/units aren’t created. If you want to buy into the fund, you must find someone willing to sell their already existing shares/units to you.
However, in most jurisdictions, it is legally possible for a close-ended investment fund to elect to create more shares/units. This is usually done when an investment fund becomes so popular that it is difficult for potential investors to find shares/units on the market.
When new shares/units are created, it will usually cause a drop in purchase price for shares/units since there is now a smaller discrepancy between supply and demand than before.