Let’s start off with definitions. A fund is a pool of money for a specific investment purpose. A mutual fund is a collection of individual funds pooled together, and managed by a… fund manager. Fund managers are then charged with the responsibility of investing in stocks/shares, bonds and other assets (they might invest in property, for example). An exchange-traded fund (ETF) is similar to a mutual fund, but is available for anyone to participate in – and you don’t need a fund manager.
It’s important to note that there are all different types of funds with all different purposes. But, when we talk about investment funds, they both have one goal: investing money, and growing the initial amount over time. Remember this.
How does it work?
An investor (people like you and me), can give money to a fund for the money to be invested. In return, the investor gets shares or units in the fund and the investor now owns part of the fund. In order for the fund to make money, it needs to invest it.
This is the fund manager’s job. Once the fund manager has enough investors giving money, the fund manager needs to invest to make a profit. The fund manager can choose to invest in Australian shares, or U.S. shares, or emerging markets shares, or even gold or oil, or any other asset. Investors pick and choose funds based on the reputation of the fund manager or the theme of the fund.
Why are ETFs becoming popular?
Mutual funds have been around for a long time. Often they can be quite difficult for new investors to invest in, as they need to contact the fund manager directly and they might reject your offer to invest. They often have large minimum amounts to invest (minimums of $20,000 or more are standard) making it very difficult for new investors to get involved.
However recently, there has been a rise of ETFs, which takes a private mutual fund and makes it public by listing it on the stock exchange/share market. This makes it much more accessible to more investors as they only need to go to the stock exchange/share market to start investing in a fund. Instead of $20,000 minimums, investors can buy as little as 1 share or as many shares as they want as it’s all publicly listed. You can invest in smaller amounts more frequently.
Why would someone invest in a mutual fund or ETF?
The fund manager is supposed to be an expert and can pick and choose stocks better than a retail investor (at least investors hope so). Good performing funds will get a good reputation and attract more investors, bad performing funds will have a bad reputation and lose investors over time.