Collective Investment Funds
When looking to begin investing one of the problems faced is being able to diversify the portfolio enough to protect against the risk of one stock failing. Opinions on the minimum number of companies to hold stock in can vary, but most experts advise a mix of between twenty and forty companies. Once the costs of commission are taken into account it may not be possible to invest in such a diverse way.
An alternative method is to buy shares in funds that exist for the purpose of holding shares in many different companies. Mutual funds, exchange traded funds (ETFs), and real estate investment trusts (REITs) are examples of such funds. By pooling your money with that of other investors, this gives you the advantage of an investment in a much wider range of companies than you would normally be able to invest in on your own. In addition, there may well be cost savings as commission rates tend to be lower when trades are made in high volumes. A collective investment scheme, also known as an investment fund, will have charges to pay for the management of the scheme that are not present when investing directly.
Collective investments can be either actively or passively managed. Actively managed funds will have a professional manager to select the stocks that provide a good return. Passively managed stocks aim to replicate the performance of a particular index by buying stocks in a way that replicates the index. A good manager will aim to outperform the index although not all managers will consistently achieve this. As the management charges for a passively managed fund will be much lower, there is no guarantee that an actively managed fund will give the best return.
There are many different types of collective investment and not all are traded on the stock exchanges. Usually the closed end funds tend to be the ones listed on the exchanges as they have a set number of shares available like any other listed company. These shares are bought and sold like any other and usual transaction charges will apply. There will also be a spread between the buy price and sell price and this will vary depending on the size and popularity of the fund.
Another advantage of a collective investment scheme is that some not only diversify across different stocks, but across the other asset classes as well. This level of diversification helps protect the investor against a fall in equities as a whole and would be hard to achieve when investing directly without a large portfolio.
Buying shares in a collective investment does mean that you are handing over some control of your portfolio. It is important to choose a fund where the manager has a similar attitude to risk to you. Investors who have a preference for investing in ethical or socially responsible companies will want to find a fund that only invests in these companies. For those with very strict criteria or looking for high risk investments there may not be a collective scheme suitable.