Investment funds explained

An investment fund is a way of putting your money together with lots of other people's money so that a professional fund manager can invest it across a range of different assets, such as shares, property or bonds, depending on the fund¹. Rather than buying one or two companies yourself, you buy a small stake in a much larger portfolio: funds pool your money with that of other investors to give you a stake in tens or hundreds of stocks, bonds or other types of investment². In return you pay charges, typically an ongoing charge of around 1% of the value of your holding each year, and some funds also levy an initial fee of up to 5.5% when you invest³.

Funds are one of the most common ways people in the UK hold investments, whether directly, inside a stocks and shares Isa or inside a pension. Standard personal pensions usually offer a range of ready-made investment funds, so many people hold funds without ever choosing one directly⁴. This page explains what a fund is, the main types, what goes inside them, what they cost, how income is treated, and what the risks are.

What an investment fund is: your money pooled with other investors

A fund is a package of investments: your money is invested with other people's money in one fund⁶. It is a collective investment, which lets multiple investors pool their money together by buying shares or units in the fund⁷. In return for a fee, an investment manager invests the pooled money on the investors' behalf⁸.

The mechanics are simple from the investor's side. You hand over a lump sum or a regular monthly amount, and in return you hold units (or shares) in the fund. The number of units you hold represents your slice of everything the fund owns. If the fund's investments rise in value, your units are worth more; if they fall, your units are worth less. The manager, not you, decides which individual holdings to buy and sell, within the rules the fund has set out.

This is why funds are sometimes described as collective or pooled investments. A pension fund works the same way: it pools money together with other investors, invests it in assets and has it professionally managed by a fund manager⁹. A with-profits fund works on the same principle too, with your money pooled together with other policyholders and invested in the policy's investment fund⁷.

The pooling is what gives a fund its main advantage over picking individual investments yourself. Investing in a collective investment fund gives you access to a broad portfolio of shares, which spreads risk and minimises the impact of any one company going bust or performing badly⁵. The same point applies across fund types: investment trusts are a type of collective investment which allows you to spread your risk and access investment opportunities⁸.

What funds offer: spread, access and a professional manager

Independent guidance sets out the main benefits of investing through a fund rather than buying individual investments yourself⁵:

• Access to a wider range of investments than you could normally buy yourself
• A professional manager making the investment decisions
• Diversification: your money is spread across a number of different investments, which spreads risk
• Economies of scale: the fund management and admin costs are spread amongst the investors in the fund
• Targeted markets: you can invest in specific markets, industries or even small unlisted businesses
• Values-based options: you can choose a fund which invests in line with your personal values and beliefs⁵

Each of these matters in practice. Diversification means your money is spread across a number of different investments, giving you a diversified portfolio and spreading risk, so a single company performing badly, or even going bust, has a limited effect on your overall holding⁵. Professional management means your investment is managed by an expert fund manager, though it does not mean the fund will do well: the manager's decisions can still lose money. Economies of scale mean the fund management and admin costs are spread amongst the investors in the fund, which is why a fund's charges can be lower, as a percentage, than the cost of building and managing a similar portfolio yourself⁵.

Access works both ways. Funds open up markets that are difficult for individuals to reach directly, such as commercial property or overseas markets, and some funds invest in line with environmental or ethical criteria, which is covered in more detail on ethical, sustainable and impact funds. The trade-off for all of this is the charges in the next sections, and the fact that a professional manager does not guarantee returns.

Unit trusts, OEICs, investment trusts and ETFs

Unit trusts, offshore funds and open-ended investment companies (OEICs) can all be referred to generically as funds⁶. The legislation that governs collective schemes recognises the same structures: a share in an authorised OEIC, a unit in an authorised unit trust scheme, or a unit in an authorised contractual scheme¹¹. Most investment funds are unit trusts, though some are exchange-traded funds¹².

The main types differ in how they are structured and priced:

The open-ended structures, unit trusts and OEICs, create units when investors buy in and cancel them when investors sell, so the fund grows and shrinks with demand¹³. Investment trusts are different: they are companies listed on the stock exchange with a fixed number of shares in issue, and an investment trust is a way to make a single investment that gives you a share in a much larger portfolio¹⁴. Because investment trust shares trade on an exchange, their price depends on demand as well as the value of what the trust owns. ETFs are also listed on a stock exchange, so you can buy and sell them at any time the exchange is open².

Where you buy funds matters too. An investment platform, sometimes called a fund supermarket, allows investors to buy and hold a range of investments in one place online, and sometimes with a smartphone app¹⁶. Many platforms offer investment funds, shares, investment trusts, ETFs, bonds and other investments, while some only offer investment funds¹⁶. How platforms work is covered in how investment platforms work, and the detailed differences between structures in OEICs, unit trusts and other fund structures, investment trusts and ETFs.

Single-asset or multi-asset funds: what goes inside

A fund's objective sets out what it invests in. Other than equities, funds can also invest in bonds and gilts, property, and even other funds, known as multi-manager funds². So the contents of a fund range from a single asset class to a mixture:

• Equity funds hold shares in companies. The income they pay out counts as dividend income, which is taxed differently from savings income¹¹.
• Bond and gilt funds hold loans to companies or governments. The income you receive from such a fund is treated as savings income¹¹.
• Property funds hold commercial property, which can be harder to sell quickly than shares.
• Multi-asset funds, sometimes described as cautious, balanced or adventurous, hold a mixture of asset types in one fund. A balanced fund sits in the middle of that range, holding a spread of assets to smooth the ups and downs¹⁷.
• Multi-manager funds hold other funds rather than, or as well as, direct holdings².

Multi-asset funds are a common starting point for people who want diversification without choosing several funds themselves. The trade-off is a second layer of cost: a fund of funds pays the underlying funds' charges as well as its own. The differences between asset classes are covered in bonds, gilts and diversification and asset allocation.

Some funds also have a sustainability objective. At least 70% of the investments in a sustainability-labelled fund must meet the sustainability objective set out by the fund's manager¹⁵, and the rules behind those labels are explained in FCA sustainability labels.

Fund charges: initial fees up to 5.5% and ongoing charges around 1%

Funds often levy an initial fee when you invest, up to 5.5%, and an ongoing charge, typically around 1%³. The ongoing charge is usually expressed as an ongoing charge figure (OCF): an annual percentage of your investments paid to the fund manager, however the fund performs². Independent guidance identifies the main cost types as the ongoing charge figure, performance fees, trading fees and stamp duty reserve tax, exit fees, and platform fees².

How much you pay depends heavily on the kind of fund:

The gap between a tracker at 0.1% and an active fund at 0.5% or more may look small, but it compounds over years, and the difference is explained in active vs passive investing. A fund's own documents state its exact charges: one cautious multi-asset fund's key investor document shows an entry charge of 0.50%, an exit charge of 0.00%, and an ongoing charge given as both 2.06% and 0.95% for the same share class, so the current figure is worth confirming with the provider before investing²⁰.

Charges do not stop with the fund. You will also have to pay an annual management fee for a fund, which can differ significantly from one fund to another²¹, and if you buy through a platform there are platform fees on top². If you take regulated advice, with investments it is common to be charged a percentage of the investment, and the average fee is 2.4%²². The full picture is set out in fund charges and the ongoing charges figure and platform fees.

Income or accumulation units: what happens to the returns

Most funds offer a choice of unit type, and the letters after the fund's name tell you which you are buying. Acc, short for accumulation, is for reinvestment, while Inc, short for income, and Dis, short for distribution, pay the income out to the investor². The choice does not change what the fund invests in, only what happens to the income those investments generate.

With accumulation units, dividends and interest from the fund's holdings are automatically reinvested, so the value of each unit rises and the income compounds over time². With income units, the income is paid out to you, usually once or twice a year, which suits people who want their investments to pay them a regular amount, a topic covered in how to invest for income.

Tax treatment follows what the fund holds, not which unit type you choose. If you choose funds that invest in equities, the income you receive counts as dividend income, which is taxed differently from savings income; income from funds investing in gilts or other bonds is treated as savings income¹¹. Holding funds inside an Isa or a pension changes the tax position, which is explained in how investments are taxed and where to hold investments. Note that income from inherited investments can itself be taxable: Income Tax applies to any profit you earn from an inheritance, for example dividends on shares¹¹.

How to start: minimums from £50 a month or £100 lump sum

You do not need a large sum to begin. Independent guidance says you can invest in investment trusts from as little as £50 a month¹, and the same figure appears across the AIC's guides: instead of investing a lump sum you can choose to invest regularly, as little as £50 per month²³. One fund provider states you can normally invest from £100 as a lump sum or £25 per month³. A pension product example shows minimums of £50 per month or lump sums of £1,000³.

The practical route for most people is an investment platform, which lets you buy and hold funds in one place online, sometimes with a smartphone app¹⁶. The steps are usually:

1. Decide how much you can invest regularly, or whether you have a lump sum.
2. Choose where to hold the investment: an Isa, a pension or a general investment account, using where to hold investments.
3. Choose a platform and open the account, covered in how investment platforms work.
4. Select the fund or funds, reading the key investor document first.
5. Set up the payment, monthly or one-off.

Regular monthly investing spreads the entry point over time, which is discussed in investing a lump sum vs investing monthly. Setting up monthly savings is covered step by step in how to set up monthly savings, and the minimum amounts in what is the minimum amount I can invest?.

Reading the key investor document before you buy

Every fund publishes a Key Investor Information Document (KIID) and a prospectus. These detail how the fund would invest your money and how risky it is, including the fund's risk rating on the 1 to 7 scale². The KIID is a short, standardised document, so funds can be compared like for like on their objectives, charges and risk.

A real example shows what these documents contain. One cautious multi-asset fund's KIID gives the fund a risk rating of 4, calculated based on the historical volatility of a similar proxy, and states that the fund may not be appropriate for investors who plan to withdraw their money within 5 years²⁰. The same document shows the entry charge of 0.50% and exit charge of 0.00%²⁰. That combination, a middle risk rating, a five-year horizon and the charges, is the kind of summary a KIID exists to give.

Before investing at all, independent guidance suggests working through the basics: whether you are ready to invest, planning tips, common mistakes, and risk versus reward²⁵. The AIC's consumer guides cover the same ground for investment trusts, including costs, getting financial advice, platforms, ISAs, SIPPs and saving for children⁸. The documents themselves are explained in fund documents: KIDs, KIIDs, factsheets and prospectuses.

Risk: the value can fall as well as rise

The value of your investments can fall as well as rise, and you may get back less than you put in¹⁰. Independent guidance is blunt about this: investing in the stock market is risky, and when you invest you could lose money¹. In extreme circumstances you could even lose all your money⁵. The success of your investments depends on the market, and as with all investments there is no guarantee you will get your money back²⁶.

Funds carry a standardised risk rating to make this comparable. Investment funds and ETFs have a risk rating on a scale of 1 to 7, where 1 is not very risky at all and 7 is very risky². Investments are also often described in words as cautious, balanced or adventurous, which reflects how far and how fast the value is expected to move¹⁷. A balanced fund is the middle of that range, not a low-risk one.

Risk ratings describe volatility, not safety. A fund rated 4 is expected to move further and faster than one rated 2, but a low rating does not mean the fund cannot fall. Ratings are also based on history, in the example above on the historical volatility of a similar proxy²⁰, and past behaviour does not bind the future. The wider framework is covered in investment risk and your attitude to risk, and the specific case of funds you cannot sell is covered in fund suspensions.

Funds are for five years or more

Independent guidance is consistent on holding periods: be prepared to keep your money invested for five to ten years, or longer⁵. For very high risk investments the suggested period is longer still: plan to invest for five, ten, or even 20 years, especially if the investment is very high risk⁵. Fund documents carry the same message: the example KIID above states the fund may not be appropriate for investors who plan to withdraw their money within 5 years²⁰.

The reason is recovery time. Markets fall as well as rise, and a fund that drops in value needs time to recover. Money you expect to need within five years is generally better held in savings, a comparison made in investing vs saving in a bank and when investing makes sense instead of saving. Guidance also suggests trying to ignore the inevitable ups and downs along the way¹, because selling after a fall locks the loss in.

Selling a fund and moving it to another provider

Unit trusts and OEICs are open-ended investments that can issue or redeem units at any time to satisfy investors who want to buy in or sell out¹³. In practice that means you can generally sell a fund when you choose, though the sale goes through at the next dealing point rather than instantly, which is explained in how funds are priced and dealt. ETFs, being listed on a stock exchange, can be bought and sold at any time the exchange is open².

Moving a fund between providers depends on the wrapper it sits in. For a stocks and shares Isa, the regulations provide that a transfer or withdrawal of funds and investments must take place within 30 days of instruction unless an exception applies²⁷, and independent guidance says it should not take more than 30 calendar days to move a stocks and shares Isa to another provider²⁸. Transfers to innovative finance Isas should take no more than 30 working days²⁸. A pension transfer often takes between two and six weeks, but the provider has up to six months to action the request²⁹.

Always transfer rather than cashing in an Isa, because selling and rebuying loses the tax wrapper's history. The process is covered in stocks and shares Isa transfers, and closing an account in how long it takes to close an investment account.

Who funds tend to suit, and where to get help

Funds tend to suit people who want diversification and professional management without choosing individual investments themselves, who can leave the money invested for five years or more, and who are comfortable that the value can fall. The AIC's guides are designed for people who are new to investing, and also for those who have invested before but are not familiar with a particular structure²⁵. People who want a ready-made choice can use multi-asset funds or the ready-made portfolios platforms offer, covered in ready-made funds and model portfolios.

Knowing your risk appetite makes it easier to pick investment funds and ETFs, which is why the 1 to 7 rating exists¹⁷. If you are unsure, free impartial help is available: MoneyHelper covers pension and investment basics⁴, and the AIC publishes consumer guides on costs, platforms and getting financial advice⁸. Be careful where advice comes from: a crackdown on finfluencers highlighted risky advice promoted on social media, and with investments it is common to be charged a percentage fee averaging 2.4% for regulated advice²². The cost of advice is covered in how much does a financial adviser cost?, and the different service levels in execution-only, advisory and discretionary services.

If something goes wrong with advice you received, mis-sold investments and bad investment advice explains your route to redress, and what happens if an investment platform fails covers where protection starts and stops.