How to Invest in Funds
Are fund shares a good investment? The short answer is, yes. However, as with any investment, research and forethought will increase your chances of a high return. In this article, we'll take a look at the basics of investing in funds.
Miguel Cervantes is often lauded as the Shakespeare of Spain. In his canonical novel, Don Quixote, he wrote, “It is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.”
Contemporary investors would likely reduce this aphorism to one word—diversification. Diversification is the financial manifestation of not putting all of your eggs in one basket. It is the opposite of dropping your savings into the current trending meme stock and hoping fortune favors you.
Savvy investors will seek to reduce risk or volatility by investing in a variety of assets. Recall the tremendous drop in value of travel and leisure related stocks during the global lockdowns of March 2020. For anyone with all their investments in airlines, it must have been a turbulent time. However, for investors with stakes in the travel and medical industries, it would have been a time for opportunity.
This kind of diversification allows you to adapt your portfolio to various market forces so that you can reap benefits from one investment, while holding out for better days on the others. Yet, the problem for hobby investors is that they often don't have the time to do their due diligence on various sectors, companies, and assets. The solution? Funds.
What is a Fund?
An investment fund is a financial vehicle that allows many individual investors to pool their money together in order to invest in various financial assets and instruments. Since these funds are held in common, they are often referred to as mutual funds.
Mutual funds offer a great opportunity for diversification because they are managed by professionals who are responsible for allocating the fund’s collective assets with the goal of maximizing capital gains. Each individual investor’s gains or losses are proportional to the size of their investment in the fund.
While funds are typically less risky than buying individual shares, money managers don’t win 100% of the time. Additionally, there are various types of funds, each with their own risk profile. For example, an index fund that broadly tracks the S&P 500® will likely come with less risk exposure than an exchange-traded fund (ETF) tracking growth tech stocks.
How Can I Buy and Sell Fund Shares?
To buy and sell fund shares you will have to set up an investment account if you don’t already have one. Unlike purchasing single shares, mutual funds typically require higher investment minimums.
Furthermore, shares of mutual funds can only be purchased at the end of the trading day and the share price does not fluctuate throughout the day. The fund will instead calculate the net asset value (NAV) after market close (4 p.m. ET).
The NAV represents the per share or unit price based on the net value of the fund after liabilities are subtracted. Therefore, if you have a $1,000 investment and the NAV posts a $50 per share value, you will obtain 20 shares.
Mutual funds typically charge fees that act as commission charges to pay brokers as well as an annual expense ratio based on a percentage of your investment. Fees will vary depending on your broker, so it would be wise to familiarize yourself with their terms of agreement before investing.
When you're ready to sell, you will do so through an authorized broker or the fund company. Your capital gains upon closing are based on the number of shares you have, multiplied by the NAV, minus fees.
Note that ETFs trade like stocks and do not require high investment minimums. Additionally, it’s possible to purchase fractional shares of a mutual fund, lowering your cost basis.
Types of Investment Funds
Each type of investment fund listed below operates with pools of capital provided by numerous individual investors in order to purchase securities and earn capital gains. Additionally, each is managed by a fund manager. Individual investors do not make investment decisions.
Now that we understand what places them all beneath the same umbrella, let’s dive into the details of each.
Most investment funds fall under the category of open-end mutual funds which are typically priced daily and issue new shares as new investors are added to the pool.
In contrast, closed-end funds are traded much like stocks, meaning that they operate with a fixed number of shares and trade on an exchange.
Exchange traded-funds, or ETFs, are relatively new financial instruments. They were developed in the 90s with the goal of providing individual investors with access to passive, indexed funds. ETFs trade on exchanges and can be traded through business hours. Some mutual funds even have ETF analogues.
Money Market Funds
Money market funds set themselves apart from other mutual funds by investing in things like cash, debt-based securities with a short-term maturity, cash equivalent securities, and other highly liquid, near term instruments. They are designed to be low risk and highly liquid.
Unlike mutual funds and ETFs, hedge funds are only made available to accredited investors. Since they face less federal regulation, they are able to invest in a broader range of asset classes and implement strategies that would otherwise be ineffective.
Difference Between Mutual Funds and ETFs
The difference between mutual funds and money market/hedge funds should appear obvious from the descriptions above. However, new investors often have a more difficult time parsing the nuances between mutual funds and ETFs.
Of course, both ETFs and mutual funds represent professionally managed baskets of securities, but they differ in some important ways. For example:
- 1 ETF share can be purchased at market price, which may be as low as $50, while mutual funds typically require minimum initial investments that are not based on a flat dollar amount, rather than the fund’s share price.
- ETFs offer more control because they have real-time pricing along with more complex order types. In contrast, the price of a mutual fund share is typically calculated at the end of the trading day, and you will pay the same price as everyone else that day.
- Mutual funds offer automatic investments and withdrawals based on your particular preferences, while ETFs do not.
Luckily, you don’t have to choose between investing in either or. Diversification of asset classes is just as important as diversification of individual stocks.
Why Invest in Funds?
Now that we have a solid grasp of investment funds, let’s review the most potent benefits they offer:
- Diversification — Harkening back to not putting all your eggs in one basket, funds significantly lower risks associated with dumping your cash into a single investment.
- Invest Expense Sharing — Fund investors cut their expenses by pooling their assets collectively. Alternatively, when an investor purchases individual stocks they are responsible for all transaction costs.
- Scale — Another benefit of collective investing is the ability of individuals to buy in bulk with their peers. This provides solo investors access to more complex assets without having to be in the know.
- Specialized Sectors — With a single investment in a particular fund, investors can expose themselves to specialized market sectors and geographic regions at a relatively low cost.
- Convenience — Mutual funds are easy to purchase. All you need is a brokerage account and the capital to meet the investment minimum.
- Portfolio Management — Rather than managing a bevy of individually picked stocks, mutual funds simplify portfolio management by delegating it to professionals.
The benefits of investing in funds is clear, but where to begin? Below are some of the top investment funds for 2022.
Best Investment Funds for 2022
Investment funds give individuals the opportunity to participate in thematic investing. Perhaps you have a passion for the environment and you want to be sure your investments are going into the pockets of sustainable companies, or maybe you predict that A.I. will disrupt the economy and offer exponential capital gains, whatever your proclivity, there is probably a fund for it.
Ethical Investment Funds
In the popular imagination, Wall Street is often portrayed and perceived as a cold manifestation of selfishness and greed. In reality, investing offers individuals the opportunity to vote on causes they believe in by spreading capital to businesses that emulate their values.
There are numerous funds dedicated to particular causes. For example, someone interested in promoting environmentalism might invest in green investment funds, sustainable investment funds, climate investment funds, or renewable energy funds, while someone wishing to emphasize youth education may seek out children’s investment funds.
Here are some examples of ethical investment funds:
- Vanguard FTSE Social Index Fund (VFTAX) — This fund excludes any companies dealing in vice products like alcohol, non-renewable energy, and weapons, and companies with “controversial conduct and diversity practices”. Its holdings include Apple, Amazon, and Apple, and it requires a minimum investment of $3,000.
- iShares Global Clean Energy ETF (ICLN) — This is a highly concentrated fund with a roster of 30 global companies involved in clean-energy related businesses. In 2020, the fund saw a 120% return. However, it is relatively volatile, with a standard deviation over 30. Some of its holdings include Plug Power Inc, Vestas Wind Systems, and Enphase Energy Inc.
- 1919 Socially Responsive Balanced Fund (SSIAX) — 25% of this fund's assets are fixed income accounts. The fund choses its holdings based on fair and reasonable employment practices, contributions to their community, and human rights record. Some of its holdings include Bank of America Corp, Apple, Alphabet, and Microsoft.
Best Performing Investment Funds
Defining the best performing investment funds is somewhat arbitrary. The funds listed below meet several criteria: they are broadly diversified, low-cost, and available on the public market.
- Fidelity ZERO Large Cap Index (FNILX) — The fund tracks the Fidelity U.S. Large Cap Index. Basically, this gives the fund broad exposure to the S&P without having to pay a licensing fee for S&P branding. Its expense ratio is $0, meaning every $10,000 invested wouldn’t cost a penny annually.
- Invesco QQQ Trust ETF (QQQ) — This is an ETF that tracks the largest non-financial companies in the Nasdaq-100. It began trading in 1999 and has been one of the top-performing large-cap funds. Its expense ratio is 0.20%, meaning every $10,000 invested would cost $20 annually.
- Shelton NASDAQ-100 Index Direct (NASDX) — Like the fund above, this ETF tracks the largest non-financial companies in the Nasdaq-100 index, but its holdings are concentrated in tech. It has boasted a strong record since it began trading in 2000. Its expense ratio is 0.5%, meaning that every $10,000 invested would cost $50 annually.
Alternative Investment Funds
Alternative investments are those that don’t fit into the conventional asset classes of stocks, bonds, and cash. These include private equity, venture capital, hedge funds, collectables like art and antiques, commodities, real estate, and managed futures. Historically, alternative investments have been reserved for institutions and wealthy individuals who have been accredited by the SEC. They are not traded on public markets and are typically not regulated by the SEC.
- AB Select US Long/Short Portfolio (ASLAX) — Focused on long-term growth of capital, this fund is primarily invested in long and short positions of US equities and is biased toward highly liquid investments.
- Virtus FORT Trend Fund (VAPAX) — This fund is invested in a diversified portfolio of futures contracts across stock, bond, currency, interest rate, and commodity markets. Their strategy is to profit from positive and negative price trends.
- Rydex Nova Fund (RYANX) — This fund is intended for investors that predict the S&P 500® will rise and desire accelerated gains. It invests in the common stock of companies that are typically in the capitalization range of the underlying index and leveraged derivative instruments.
Final Thoughts: Are Fund Shares a Good Investment?
Are fund shares a good investment? The short answer is, yes. However, as with any investment, research and forethought will increase your chances of a high return. For new investors, or investors who want to outsource market analysis, mutual funds offer a simple, relatively safe investment. Even investors who want to be more hands on would likely be well served by having a portion of their portfolio in investment funds. Diversification is key.
The information in this article is intended for educational and entertainment purposes only and cannot be considered investment advice.