Funds explained: the mechanics of investment funds
Funds are promising investment options for investors. But what exactly are funds and how do they work? Learn about the different types of funds, what benefits they offer, and what you as an investor should be aware of.
Funds combine investors' capital
You can think of a fund like a melting pot: capital from multiple investors is pooled together in order to be invested more promisingly. Each individual investor acquires unit certificates on the fund's total assets. There is no minimum limit as to how much capital must be invested.
In the best-case scenario, the value of the unit certificates grows over time. If this is the case, the investor receives a profitable return when selling the security. Usually, unit certificates can be bought or sold at the current market value at any time. Thus, you are guaranteed a high degree of flexibility and liquidity when investing.
Characteristics of investment funds
One decisive advantage of funds is diversification. As with all types of investment, funds are subject to market fluctuations. To mitigate this, investment funds comprise several different securities. It can be various companies, regions, or asset classes. This results in a diverse portfolio that spreads the risk around: losses on individual securities are mitigated by the diversity of having several securities.
In addition, investment funds are considered special assets. This means that the fund management company stores the invested capital separately at a custodian bank. Your investment is therefore protected in the event that the issuer becomes insolvent prior to bankruptcy.
Types of investment funds and their return potential
Investors can choose from a wide variety of funds. For example, you can invest according to investment strategy, according to regions or specific topics, such as the Credit Suisse Supertrends. There are also funds for different asset classes, such as real estate funds or equity funds. Using funds, you can even invest in markets, such as China, that are otherwise difficult for private investors to access.
There will also be differences depending on the time horizon. If you're looking to invest long term, you can consider funds with a large proportion of equities. If you're only looking for a short-term investment, money market funds and bond funds are better as they are less risky.
The main categories of investment funds
Money market funds
Money market funds contain money market securities and other fixed-interest securities with short maturities and high credit ratings. You can invest in them for even just a few months. The risk is rather low, but so are the returns.
Bond funds consist of securities with fixed or variable interest rates and various maturities. Bond funds are a little bit riskier, but the returns are also higher. For bond funds, we recommend a time horizon of between four and five years.
Equity funds may be oriented geographically, by sector, or by the size of the company. They are exposed to relatively large price fluctuations and are thus the riskiest of funds, but they offer the best opportunity for returns. Your time horizon should be at least five years.
Passive investment funds
Funds can be managed either actively or passively. Passive funds reflect the market by following a selected benchmark index such as the Swiss Market Index (SMI). The process is automated and no fund manager is involved. This reduces the administration costs for investors and makes passive funds a cost-effective investment option. Passive funds include index funds and Exchange Traded Funds (ETFs). ETFs are continuously traded on the stock market, whereas index funds are not listed on the stock exchange and are issued by financial institutions.
Active investment funds
For actively managed funds, managers carry out real-time market analysis on economic trends and company-specific factors. They try to determine the most attractive prospective investment options as well as entry and exit points before the broader market reacts. This means that actively managed funds have higher management fees than passive funds.
However, active management is better for markets with high divergences and volatility. This is because fund managers can take protective measures designed to limit losses. At the same time, they try to increase returns and outperform the market. Fund managers selectively buy unit certificates whose value they think will increase, and sell securities that they believe will fall.
Five tips for investing in funds
- Take your own circumstances and risk tolerance into account when selecting a fund
- Invest in a broadly diversified fund portfolio
- Define a long time horizon
- Immediately invest part of the capital and stagger the rest
- Consider the market situation when choosing between active and passive management