A fund is a pool of money which is professionally managed to achieve the best possible return for investors. When money is paid in the manager uses it to buy assets, typically stocks and shares.
The idea is that by combining your money with other people's, you can spread it between a wider range of companies than if you were investing alone. This lowers the risk of your investment.
There are many different types of funds, but the main ones you will probably encounter if you are investing through an Isa, pension or monthly savings scheme, are unit trusts, OEICs and investment trusts.
Funds tend to be run around themes – a manager will often focus on a particular sector, or he or she may aim to produce an income for investors, or to produce capital growth.
Most funds are available to people with a lump sum to invest and to those who want to make regular payments.
Fund managers will apply different rules on minimum contributions – some will accept monthly payments of £50 or more, but others may set the bar much higher.
Unit trusts
Unit trusts and their more modern counterpart open-ended investment companies (OEICs) make up most of the investment fund market.
The funds are split into units and you buy some when you invest.
The value of those units goes up and down in line with the performance of the assets in which the fund manager has invested.
The number of units that make up the fund increases and decreases as investors put money in or take it out.
When people want to cash in their investment, the fund manager will sell assets to realise the cash.
If the fund manager is doing a good job, the underlying investments should increase in value over time and when you decide to cash in your units, they will be worth more than when you bought them. This will be the profit on your investment.
Investment trusts
Like unit trusts and OEICs, investment trusts are pooled investments that bring together money from a number of investors.
However, this type of fund is run as a company and when you invest, you buy shares in it which are listed on the stock market.
This means the value of your investment is affected by the ups and downs of the market as well as the performance of the assets chosen by the fund manager.
While the number of units in a unit trust fluctuates, the number of shares in an investment trust is constant and if you want to cash in your investment you will have to sell your shares.
The cost of shares in an investment trust does not usually accurately reflect the value of the underlying assets – most trade at a discount to their real value.
Sectors and themes
The managers of unit trusts, OEICs and investment trusts will have a fund objective, which is outlined in literature given to potential investors.
They may choose to target income, capital growth or a combination. They will usually do so within a particular sector or according to a particular theme.
So a fund may be a UK growth fund, which aims to increase the value of an investor's capital by buying shares in companies based in the UK, or it may be a smaller companies fund, which invests only in companies below a certain value.
There are hundreds of different sectors, some containing many more funds than others. The smallest sectors are the most specialist, offering funds that focus on a small geographical area or a tiny area of the market.
Tracker funds
These are funds which track the performance of a particular market or index. In theory, two tracker funds tracking the same thing should produce equal performance, but in practice this isn't the case.
Different charging structures and different ways of tracking can result in two funds producing different returns.
Because tracker funds are not actively managed, they tend to have lower costs than managed funds.
Choosing a fund
The suitability of a particular growth fund will depend very much on why you are investing.
If, for example, you are investing to build up a lump sum to repay your mortgage or pay for your children's education, you ought to concentrate on funds focused on mainstream, lower-risk investments such as blue-chip shares or unit trusts that have some gilts in their portfolio.
If you fall into this category, you should probably confine your search to the UK equity growth sector and plump for broad-based funds.
But if you have no specific purpose for investing and can afford to take a risk, a move into funds which invest in smaller companies, technology and the internet, or overseas and emerging markets could be more rewarding.
Associated costs
Most unit trust and OEIC investments have upfront charges, although discount brokers will rebate most or all of these fees to customers.
In most cases you won't pay more than a 1% initial charge on a unit trust if you use a discount broker.
If you choose to go directly with a fund manager, it will usually cost you between 3% and 5% of your investment. Managers also charge anything from 1% to 1.5% each year for their services.
Buying an investment trust tends to be cheaper, as upfront costs can be as low as 0.5% of your investment and annual management fees may be less than 1%.
Fund supermarkets
Like discount brokers, fund supermarkets usually offer a discount on upfront fees, helping you to make sure as much of your money as possible goes into your investment.
They also allow you to spread your money between funds from a range of fund managers.
This can be useful if you want to hold a variety of funds in your Isa wrapper and want to buy them from different companies.
Potential pitfalls
As with any investment that relies on the whims of the stock market, there are risks involved in putting your money into funds.
The level of risk will depend on the underlying investments. A fund spread across a range of companies and asset classes, for example, will offer more security than a fund which invests only in one industrial sector, such as technology.