You cannot, after all, go and buy shares in just any company and expect them to go up in value. You need to do thorough research first to understand what moves share prices and where there are opportunities to make money.
Read more about what factors influence share prices.
Learning about the stock market and successful investing takes, like anything else, time. Even when you feel you understand enough, there is no guarantee you will make money – even the most experienced tipsters can get it wrong. And, if you only have a small sum to invest, taking a chance with your hard-earned cash may be more of a risk than you are prepared to take.
This is why most investors entrust at least some of their money to professional money managers who buy shares for them through investment funds. Even if you do want to invest money yourself, it makes sense to have at least some money in a fund as they can provide a whole host of benefits you are unlikely to achieve investing on your own.
Investment trusts
Unit trusts
OIECs/ICVCs
Investment funds work by pooling your cash with that of other investors and investing it in a broad range of shares. The benefit of this is not only having your money managed by an expert but that you gain access to a wider range of shares than you could buy yourself.
If you were to buy shares yourself it is unlikely you could afford to invest in a very diverse portfolio. Most experts say that you should look to invest in at least 10 companies to get a decent level of diversification and put around £1,000 in each. But if you invest in a fund it doesn’t really matter if you invest £50 or £10,000 a month. Your money will be spread across a wide range of companies, typically at least 50.
This is a far less risky approach to investing – if the shares of one or two of the companies you are investing in drop in value, the increase in share prices of other stocks should mean your investment will continue to grow.
Buying an investment fund does not only give you diversification across a range of companies but can also give you exposure to stock markets around the world. Most major fund groups offer funds that invest not only in the UK but Europe, the US, Japan, Asia and other emerging markets.
Some groups also offer more esoteric funds focusing on specific countries, say China, or global industries, such as technology and healthcare.
But while the fund managers running these investments are professionals, there is no guarantee you will make strong returns. Fund managers can go through periods of poor performance and some are better than others so you need to choose your investment carefully.
Read more about picking funds.
Like shares, investment funds can be sheltered under the tax-free umbrella of the Individual Savings Account (ISA).
Read more about ISAs.
Before you go and buy a fund, you need to decide which type you want: a unit trust; OEIC/ICVC or investment trust. Each spreads your money across a range of investments but there are some important differences in the way they work and how they perform.
If you put money in a unit trust you buy units in a fund. The price of these units is determined by the value of the assets it holds. Every time a new investor puts money in the fund, more units are created by the manager with a value equal to those already in existence.
When units are sold, the reverse happens – if the fund manager cannot find a buyer for the unwanted units, they are cancelled. This means that the unit trust’s size is not restricted and so it is often referred to as an ‘open-ended’ fund. If you look for the price of a unit trust in a national newspaper or magazine, you will see they have one price for investors who buy units, known as the buy or offer price, and a different price for investors who sell, known as the sell or bid price. You will notice that the offer price is always higher than the bid price.
This difference, known as the bid-offer spread exists to take account of the fund managers’ charges and commissions. More recently, unit trusts have been granted the option of single pricing, but some still use the old method Unit trusts have, however, become outdated because they don’t give investment groups enough flexibility and because they cannot be sold in other parts of Europe.
This has resulted in the creation of a new type of fund. These funds are usually known as Open Ended Investment Companies (OEICs) but can also be called Investment Companies with Variable Capital (ICVCs).
These new funds do exactly the same job as unit trusts but just in a more modern format. The funds are, like unit trusts, open-ended but they issue shares rather than units.
With both unit trusts and OEICs/ICVCs the price you pay relates directly to the value of the fund’s assets but all the confusion over unit trusts’ bid and offer prices is swept away – OEICs and ICVCs have a single price. All charges are then quoted separately, making it easier for you to see exactly what you are paying for.
This brings British funds in-line with funds sold in other countries. Investment trustsInvestment trusts are more complicated than unit trusts and OEICs/ICVCs and this has deterred many investors, particularly those new to the stock market.
But they have some interesting features that can help them produce better returns than other funds so it is worth taking the time to understand them. Investment trusts are simply listed companies whose sole business is, like other funds, buying shares in other companies. They raise a fixed amount of money from investors which is then used to create a limited number of shares that are then traded on the stock market, just like the shares of other companies.
Because they issue a limited number of shares, investment trusts are often referred to as closed-ended funds. Once the trust has issued shares it effectively acquires two values – its share price and the value of its underlying assets. These two values can move independently of each other – if demand for the shares is high, the share price will move above the value of the assets, known as a premium.
But, if demand is low, the trust’s price will drop below the asset value, known as a discount. This difference in price is used by experienced investors to make money. If they see a trust’s shares are trading at a discount but they think demand is going to rise, they can buy the shares and wait for an increase in price. If the price does rise and the value of the assets goes up at the same time, investors can get a ‘double whammy’ effect.
Investment trusts can also provide better returns than other investment funds by borrowing money from the bank to invest. This process, known as gearing, can boost returns if markets rise but can result in bigger losses if share prices fall. Investment trusts are often managed by the same people who manage unit trusts and OEICs/ICVCs so if you are confident, you can get a performance advantage from switching from a unit trust to an investment trust when the trust is at a discount and back again if it moves to a premium.