How to Invest in Funds in the UK

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Contents:

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A fund pools money from you and other investors, and a specialist fund manager invests it on your behalf in assets such as shares, bonds, properties and commodities.

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Instead of buying these individual assets yourself, you can choose to invest in a fund. Funds save you the trouble of buying shares in multiple companies or worrying about building a diversified portfolio. They are also safer and cheaper than buying individual stocks since you share the risks and costs with other investors. Most people, including experienced investors, use funds when investing.

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There are several types of investments that make up a fund, and they range from stocks and shares to bonds, commodities and even commercial real estate.

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When you buy a unit of a fund, you are investing in a variety of these types of investments at a relatively low price. Such investments include:

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1. Stocks and Shares: A share is a unit of ownership of a public company. If, for example, you invest in Apple Inc. shares, you will become a part-owner of Apple. If it performs well, you will benefit from its success. If it does not, you may lose some money. Shares are also called equities or stocks.

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2. Corporate Bonds: When you invest in a corporate bond, you are lending money to a company in return for interest.

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3. Government Bonds: When you invest in a government bond or gilt, you are lending money to a government in return for interest.

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4. Commodities: When you invest in commodities, you are investing in precious metals (gold, silver), oil, agriculture, etc.
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5. Properties: When you invest in property, as the name suggests, you are investing in real estate.

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There are two main types of funds: active funds and passive (index) funds.

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What is an active fund?

An active fund is a fund actively managed by a team of fund managers. These fund managers employ various strategies to pick shares, bonds, and other assets they think will do well with the goal of outperforming the stock market and other competing funds. But, there are no guarantees. While some fund managers certainly beat the stock market and reel in huge chunks of returns for investors, others do not.

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Active funds are usually more expensive than passive funds because you pay extra for the active service.

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Most funds in the market are active. Investment providers always tell you whether funds are active or passive.

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What is a passive (index) fund?

A passive fund (also known as an index or tracker fund) is different from an active fund in that rather than attempting to beat the market, the fund managers track it. This simply means that fund managers often buy shares in every company listed on an index with the goal of performing exactly as the index does instead of picking individual shares or bonds they think will do well, as is the case with active funds.

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An index is simply a list of shares or bonds in any given market. You may have heard of the FTSE 100 index. It is an index of the 100 largest companies on the UK stock market. A passive fund tracking the FTSE 100 index, for example, will buy shares in all the companies on that index. So, if you purchase a FTSE 100 index fund, you will be investing in the 100 companies with the highest market capitalisation on the London Stock Exchange. 

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Similarly, if you buy a FTSE All Share index fund, you will be investing in all the companies listed on the London Stock Exchange that pass the screening for size and liquidity.

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Most people invest a portion of their long-term or retirement savings into passive funds because they are less volatile than their active counterparts. Passive funds tend to deliver healthy returns over a long-term period, but they never outperform or underperform the market as active funds do.

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Examples of passive funds include index funds and exchange-traded funds (ETFs).

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What is an ETF?

An exchange-traded fund or ETF is an index fund that can be traded on the stock exchange like a share. ETFs and index funds are pretty much the same thing, with the main differences being that ETFs are traded on the stock market (this means you can buy or sell them at any time during the day, just like shares), and sometimes, they have extra fees.

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For examples of popular index funds and ETFs, see Best Index Funds and Best ETFs.

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To invest in funds, you need to choose one or more investment themes (e.g. stocks only, stocks and bonds, UK large-cap companies, government bonds only, commercial real estate, US mid-cap, technology companies, etc.); then decide whether you want to receive or reinvest dividends; next, choose a tax wrapper; and finally, find an investment platform. 

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Here’s what we mean:

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1. Choose one or more investment themes

Funds usually have a specific theme or sector around which all investments are structured. Themes tell you which area of the market a fund is invested in, allowing you to make a preliminary judgement on the fund’s risk level and to invest in alignment with your interests, values, and objectives. For instance, if your ethical values are a factor when choosing your investments, you might want to invest in funds with a socially responsible or green theme. Fund themes could include but are not limited to:

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• Company size: large-cap, mid-cap, small-cap, unicorns, etc.
• Asset type: shares, corporate bonds, government bonds, commodities, etc.
• Industry: real estate, technology, utility, etc. 
• Geography: America, UK, Europe, Emerging Markets, Africa, etc.
• Ethics: companies with high environmental, social and governance (ESG) scores

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2. Decide whether you want to receive or reinvest dividends

When you invest in funds, you might receive regular income from your investments. Many funds allow you to collect this income or reinvest it in your portfolio automatically.

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If you choose “income”, you will receive regular payments in your bank account. This income comes from the dividends of the companies in which the fund invests.

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If you choose “accumulation”, your income will be automatically reinvested, which will increase the total value of your investments and, by extension, the price of each unit of the fund. Most people investing to grow their money in the long term usually buy funds of the accumulation class.

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3. Choose a tax wrapper

A tax wrapper reduces the amount of taxes you pay on your investments. Examples of tax wrappers in the UK are Individual Savings Accounts (ISAs) and pensions.

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Here is a detailed breakdown:

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1. Stocks and Shares ISA: A Stocks and Shares ISA lets you invest your tax-free ISA allowance in qualifying investments such as shares, corporate bonds, government bonds (gilts) and funds. This tax year, your ISA allowance is £20,000. This means you can invest up to £20,000 into a Stocks and Shares ISA without having to pay tax on the gains from your investments. A Stocks and Shares ISA is also called an Investment ISA.

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2. Lifetime ISA: A Lifetime ISA is open to adults aged 18 and over but under 40 and lets you save or invest up to £4,000 a year towards your first home or retirement. The government will add a 25% bonus to your savings every year up to a maximum of £1,000 per year.
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3. ‍Pensions: Tax relief is available from the government when you pay into a pension, but you can’t access the money until you turn 55 (increases to 57 in 2028), when you can take 25% as a tax-free lump sum.

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It is also worth mentioning that if you do not want to use a tax wrapper, perhaps because you’ve already used up your ISA allowance for the tax year, you can choose to invest in a general investment account (GIA).

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With the GIA, the first £3,000 profit you make on your investments is tax-free. Additionally, your first £500 in dividends is also tax-free.

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4. Find an investment platform

You can buy funds from banks, building societies, stockbrokers, fund supermarkets, robo advisors, trading apps, and other financial institutions. The specific provider you choose will depend on your objectives, investment savviness, and personal circumstances. Scroll down to discover some of the best fund providers in the UK.

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Once you are ready to invest, you’ll have to pick a fund provider and choose funds from the selection offered by your provider. You should know your objectives and risk appetite and have a rough idea of the kinds of investments you want in your portfolio. It would help if you also plan to invest for at least five years and ensure that you are not heavily indebted or cash-strapped before you begin.

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Here’s how to choose funds:

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1. Know your objectives: Why are you investing? Is it for retirement, buying a home or some other long-term goal? For example, most people investing for retirement will have their eye on passive funds.

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2. Consider your risk appetite: The higher the return you want, the higher the risk you’ll have to be willing to accept. It’s usually wise to take on more risk when you are young with many years ahead of you to ride out any dips in the market.

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3. Keep an eye on costs: ‍There are several charges associated with investing in funds. These charges are usually displayed as a flat fee or a percentage typically below 1%. While that may not look like much on the surface, costs tend to add up over time. As a general tip, percentage-based charging tends to work out cheaper for people who do not have a lot of money to invest. In contrast, flat fees are usually cheaper for people who have a lot of money to invest.

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4. Build a diversified portfolio: Using the fund themes above, you can build a diversified portfolio of funds based on your interests and objectives. We emphasise diversity because top-performing funds vary from year to year, so investing in different asset types (e.g. shares, bonds) and different geographies (e.g. America, Europe, Emerging Markets), for example, is usually a good idea. This way, you are never overexposed to just one market. It is also important not to be too diversified, as an over-diversified portfolio can only ever be average.

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To learn how to build a diversified portfolio, read How to Invest in Your 20s and 30s.

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We’ve outlined some typical fund fees below. You can always find the full details of a fund’s charges in its Key Investor Information Document (KIID).

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Quick Tip: Fixed fees tend to work out cheaper for people investing high amounts, whereas percentage-based fees tend to be less expensive for those with little to invest.

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1. Annual Platform Fee: This is charged by the investment provider for providing a platform for you to invest in.

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2. Annual Fund Management Fee: Also known as Ongoing Charge Figures (OCF) or Total Expense Ratio (TER). This is the fee paid directly to the fund manager responsible for managing your funds. When you invest in funds, you typically select a few funds to invest in. If you selected three different funds, for example, you would have to pay a fund management fee for each fund.

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3. ‍Market Spread: Also known as transaction cost. This is the difference between the buy and sell price of an asset.
   
   
4. Annual Investment Cost: Some providers display this cost as the annual fund management fee plus the market spread.
   
   
5. Trading Fee: Also known as dealing fee. This is the fee for buying and selling funds, shares or other types of investments on the platform. It usually ranges from £0 to £25.‍‍
   
   
6. Transfer-out Fee: Also known as an exit fee. It is the fee you pay for moving your investments from one fund provider to another. Not all platforms charge an exit fee, but those that do typically charge per fund or holding.
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7. Advice Fee: This is only paid if you opt-in for financial advice.

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We’ve compiled a list of some of the best fund providers in the UK. These are our top websites, apps, trading platforms, and investment providers for buying, selling, managing, or gifting UK and overseas funds, stocks, and other trading products.

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Capital at risk. Other charges apply. ISA rules apply.

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Here are the best fund providers in the UK:

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Yes, you can move funds from one platform to another, provided the platform you are switching to sells the same funds as the old platform. If it does not, you will have to sell your funds on the old platform and start afresh with different funds on the new platform.

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You enjoy tax benefits when you hold your investments in an ISA or pension. You can invest up to £20,000 into a Stocks & Shares ISA tax-free this tax year. If you choose to invest in a general investment account (non-ISA), you are allowed to make up to £3,000 in gains tax-free. Additionally, the first £500 you receive in dividends is tax-free. Scroll up to learn more about tax wrappers.

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Funds can be a great way to build a diversified portfolio without investing too much of your own time or energy into researching multiple stocks, bonds or other assets. Buying one unit of a fund can expose you to more stocks and bonds than if you were to invest directly in the market yourself. Funds allow you to gain access to a range of markets around the world and a wide variety of industries and specialist asset classes. You must still keep in mind that investing in funds will usually always involve taking on a certain degree of risk, and this should be considered carefully before investing.

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When you invest in a fund, the fund manager will decide the exact choice of investment. Depending on the type of fund you choose, your investment will either be actively managed - where buying and selling are done more frequently, with the aim to deliver a return better than the stock market, or passively managed - where the fund replicates the market and aims to grow as the market does. In your chosen fund, you’ll buy ‘units’, which can increase or decrease depending on how well the fund performs. If you multiply the cost of each unit in your fund by the total number of units, you’ll know the value of your investment before fees.

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Funds are a great investment option for those who feel they do not have the time, expertise or commitment to manage their own portfolio of investments. When you purchase a fund, you are effectively delegating responsibility for managing your money to a fund manager. This fund manager invests your capital (pooled with that of other investors) into thousands of assets across multiple industries and geographies. You will still have the freedom to choose the asset class and theme.

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No, not all funds pay dividends. Funds have two classes based on whether or not they pay dividends. You can choose to buy funds in either “Income” or “Accumulation” classes, depending on whether you want to receive or reinvest your dividend. Income means you will receive regular dividends, while Accumulation means your dividends will automatically be reinvested (increasing the size of your portfolio).

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Funds are generally considered to pose fewer risks than individual shares since they include a variety of assets and are overseen by paid fund managers who work on behalf of the investors. But, it’s still important to keep in mind that there are no guarantees when investing, and some funds may even pose higher risks depending on the theme or combination of the fund itself. For example, if the fund was focused entirely on the technology sector, and that particular sector began performing poorly, the lack of diversification would result in that fund underperforming.

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Here are the best platforms for buying funds in the UK:

1. Interactive Investor - One free trade per month; 40,000+ Instruments
2. AJ Bell - Low cost; Lots of research; 15,000+ Instruments
3. InvestEngine - Low cost; 500+ Commission-free ETFs
4. Hargreaves Lansdown - Lots of research; 15,000+ Instruments

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