Investment funds are investment vehicles created for the purpose of collecting assets from investors and channeling those assets into a portfolio of financial instruments such as stocks, bonds and other securities. Investment funds offer small investors the chance to have a professionally managed and diversified basket of financial instruments at affordable costs.
Benefits
Investing in funds has several benefits:
1) Professional management: Funds have full-time professional managers who research and spot suitable investment opportunities. The time, effort and expertise they devote to investments far exceed those affordable to a single investor.
2) Cost efficiency: Since funds manage a large number of investments, the trading and research costs are spread among investments.
3) Diversification: Most funds invest in a variety of investment classes and companies, therefore protecting investors from the collapse of any single class of investment or company.
Mutual Funds
A mutual fund is a big pool of money from many investors. The mutual fund manager uses this money to invest in stocks, bonds and other investment instruments meeting the fund's criteria. To invest in a mutual fund, you buy shares to become a shareholder of the fund. Most mutual funds have reasonable minimum investment requirements ($1,000 or less) and are affordable to the general public. Investors can choose different funds based on their risk-taking profile: Stock funds invest more heavily in stocks and have ups and downs over time; bond funds offer steady current income; and money market funds (investing in short-term debt) ensure that the invested principal does not decline in value in the short term.
Hedge Funds
Hedge funds have historically been the domain of wealthy investors. They are like mutual funds in that they typically invest in stocks and bonds; however, they take higher risks, such as short selling---i.e., selling borrowed shares in the hope that the price of the shares will drop later. Hedge funds charge a higher annual fee (1 to 2 percent) than mutual funds and also demand a typical performance fee of 20 percent. Hedge funds are not subject to the same regulatory oversight as mutual funds; therefore, their operations are usually considered more opaque.
Index Funds
In actively managed funds such as mutual funds and hedge funds, portfolio managers and analysts scour the market for investment opportunities. In index funds, managers passively invest to match the performance of a market index such as the Standard & Poor's 500 index---i.e., stocks of 500 large U.S. companies. An index fund buys and maintains stocks in the same ratio that constitutes the target index.
Fund of Funds
A fund of funds is a fund that puts money into other investment funds or target funds. The basic idea is that the investors hand over the selection of funds to professional fund managers instead of choosing funds themselves. Funds of funds enjoy a double risk spreading---i.e., diversification at the level of target funds and at the fund of funds' level itself.
