Here’s how each type of investment works
When you start investing in the stock market, there’s a big choice to make. Should you buy shares or funds? There’s no right answer to this – there are pros and cons for both.
In fact, many investors end up mixing shares and funds together in their portfolios. In the end, the most important thing is to understand what you’re investing in and why you’ve bought it.
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What are shares?
Shares are small parts of companies that are publicly listed for sale on a stock market. Some investors focus on shares listed on the London Stock Exchange but you can also buy shares listed on the stock markets located around the world – the US, Europe and Asian stock markets are particularly popular with UK investors.
Over the decades share ownership by ‘retail’ investors, individuals like you and me, has reduced.
In 1963, according to the Office for National Statistics, retail investors owned around 54% of UK quoted shares in terms of total value. However, by 2022, the figure had reduced to just 10.8%.
One factor in this trend may be that many people find the thought of investing in individual company shares too daunting or time-consuming (more on that later) so they invest in funds instead.
Another factor may be that Warren Buffett, the famous US investor who made a fortune picking successful shares, has been outspoken on how he thinks ordinary non-professional investors should invest. He believes the average person would be better off buying index funds, such as a fund that tracks performance of the largest US index, the S&P 500, rather than individual shares, because successful investing takes time and expertise.
Also, even professional investors often make the wrong calls when investing.
What are funds?
Funds such as Oeics, exchange traded funds (ETFs), and investment trusts enable you to invest in the stock market by pooling your money with that of other investors. That means by owning a part of a fund, you can instantly spread your investment across lots – sometimes 100s – of different listed companies. Some funds buy shares in private companies too, or other types of investments such as commercial property and gold.
If you invest into a fund you won’t own the shares directly. Instead, you will own a small part, or unit, of the fund. The collection of shares and other investments that the fund buys is called its portfolio and the price of the units that you hold in the fund will reflect the underlying portfolio’s value.
The money is managed by a professional fund manager in line with an agreed strategy, such as income or growth, or often both.
In the case of active funds, the manager selects at least 25 shares, but usually 50-100, and aims to beat the performance of a selected benchmark such as a stock market index or a peer group of similar funds.
With ‘passive’ funds, the money is managed with the aim of delivering the same performance as a stock market index, such as the FTSE 100 or the S&P 500. To track that performance, the fund will usually buy all the shares in the index.
Check out our list of the cheapest ISAs for investments
Advantages and disadvantages of investing in shares
Buying shares allows you to tailor your investments exactly to the companies and growth themes that interest you. That’s a greater level of investment control than investing using funds. If you bought a fund, you can’t always see all the investments – usually only the top 10 companies held in the portfolio are shown on a fund’s fact sheet.
However, putting a large amount of money into a single business can be risky. Even the largest, best-known companies can experience problems such as poor management or competition from elsewhere that means their share price falls.
Ideally, you’d need to buy at least 25 companies that operate in different sectors of the economy, such as consumer, financial and industrial businesses, to spread your risk, so you might need a larger initial outlay than buying funds. Ideally you would also buy overseas shares too, getting exposure to the US, Europe and Asian economies.
There may also be dealing charges for buying and selling the individual shares, which can mount up. Plus, you then need to be prepared to do the research and monitoring that’s needed.
It’s easy to get sucked into buying fashionable companies that are in the news, for example the ‘tech giants’. If lots of investors buy into these companies, the share prices might continue moving up, but fashions can change and the positive sentiment might reverse suddenly, leading to losses.
Investors often buy companies because they are attracted to their products or services. There’s nothing wrong with this approach as long as that’s not the only reason for buying. You also need to research the ‘fundamentals’ – reading the annual reports and updates from the company. And you’ll need to identify and monitor the key facts about a business that can make it a good or bad investment.
Buying individual shares can go wrong if you don’t do the proper research that leads you to make an informed decision about whether to buy – and when you should sell.
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Pros and cons of funds
Buying funds can be a cheaper, less risky, and less time-consuming way to invest. Rather than 25 shares (or the number that you’re prepared to monitor and research) you can instantly have exposure to 100s or even 1000s of companies. Plus, if you’re only investing small monthly amounts or a modest lump sum, funds could be the more advantageous option. You can start with as little as £25 a month or a £100 lump sum.
Unlike shares, many investment platforms don’t charge for buying and selling funds. But there is a fee charged by the fund manager, usually a very small percentage of the money that you invest – say 0.2% up to 1% a year. Passive funds tend to be lower cost than active funds.
Nevertheless, even when you’re buying funds, you should still do some research. There are lots of different fund types, while the underlying investments and strategies can vary too. Plus you should try to keep fund fees as low as possible, even when choosing active funds. So take some time to dig into the options when choosing your funds.
Which should you buy?
Some investors like doing a lot of research and treat share investing as an enjoyable hobby. But taking all the pros and cons into account, lots of investors take a small amount, say 10%, of their total investment as ‘play money’ to invest in shares. This means they can be involved in the economy and react to investment news and maybe have some fun too.
But they then invest the bulk of their money in a core portfolio of funds, often passive funds so they don’t run the risk of underperforming the stock market.
