What you need to know about investment funds
Investment funds are the cornerstone of savvy investing, but there are several types available and it’s important to know the pros and cons of each.
Understanding how investment funds work is key to knowing how to invest your wealth effectively.
But the array of designations, acronyms and fees can feel overwhelming, especially for beginner investors.
The key advantage of investing using funds, rather than picking individual stocks, is that it immediately offers diversification.
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“As a general rule, diversification tends to be your friend and prevents one or two isolated problems from wrecking your portfolio,” says Ben Seager-Scott, chief investment officer at Forvis Mazars.
“Funds give you ready access to a spread of companies without being overly exposed to just a handful,” he continues. He cites legendary investor Harry Markowitz who reportedly said “diversification is the only free lunch in investing”. Funds offer this diversification, without much of the cost, administration and time commitments that building your own portfolio from scratch would entail.
“You could choose to manage a portfolio directly if you have the time to understand and research all of the stocks, listen to the earnings call, decide which winners to allow to run higher versus which ones to take profit on, which stocks to top-up after a fall or close out of… and so on,” says Seager-Scott.
But if you buy a fund, a professional – whether that is a fund manager or an index compiler – is doing that for you.
The different types of investment funds
Investment funds come in various forms – so many, in fact, that categorising all of them is almost impossible. But there are three broad categories that it is especially useful for investors to be familiar with, and which cover most of the range of possible investments between them. These are ETFs, mutual funds and investment trusts.
There are two key distinctions that define these three fund types: open- versus closed-ended, and listed versus unlisted.
“Open-ended means clients can put money into the fund and take it out of the fund which makes the fund itself grow or shrink,” says Seager-Scott. Closed-ended, on the other hand, means that all the fund’s capital is raised and all of its shares are issued at its inception.
“Listed means the shares are listed on the stock exchange so can be traded through the day on this secondary market, whereas unlisted means you trade effectively directly with the fund group (although in reality it is still intermediated) once per day,” says Seager-Scott.
Mutual funds
This is a broad category, but essentially it refers to open-ended, unlisted funds.
“There are lots of varieties, including OEICs (which are UK-domiciled), unit trusts (which are an older style of UK-domiciled fund) and SICAVs (which are EU equivalents),” says Seager-Scott.
The biggest difference between a mutual fund and other types is the fact that a mutual fund isn’t listed on a stock exchange. Units in the fund are bought directly from the fund group via an investment platform once per day.
They can come in various forms: there are passive index funds and actively-managed strategies, and they can cover any kind of asset – from stocks and shares to bonds or commodities.
For this reason they are one of the most versatile asset types in your portfolio. You could invest quite successfully over the long term without ever buying individual stocks or commodities, and let a judicious selection of funds give you the focus you’re looking for instead.
If mutual funds sell off too rapidly, they can be forced to close – as the fund manager needs to sell assets to meet the ‘redemption requests’ when holders sell their units.
ETFs
Exchange-traded funds (ETFs) are open-ended, listed funds. As the name suggests, they are listed on a stock exchange: you can buy and sell them in a stocks and shares ISA just as you might buy shares in a listed company. That makes them a simple type of fund for beginner investors.
“When you buy a mutual fund, you often won't know the exact price you are paying until the market closes for the day,” said Tom Bailey, head of research at ETF issuer HANetf. “In contrast, an ETF has a live price during market trading hours.”
Despite trading on a stock exchange, the price of an ETF will always reflect the net value of its underlying assets (net asset value, or ‘NAV’). This is because new shares can be created or redeemed by authorised partners to ensure that changes in demand for the ETF’s shares are always balanced against changes in its NAV. This is what is meant by ‘open-ended’.
Like mutual funds, ETFs can give you exposure to any kind of asset class. Historically they have been associated with passive funds, but you can also buy active strategies in ETF form. This is an increasingly popular choice – while active ETFs make up a relatively small portion of the total, data from ETFBook and HANetf shows that they were the fastest-growing category of ETF in Europe during Q2 2026.
Investment trusts
Investment trusts are closed-ended funds. They are also, technically, listed companies – they are often referred to as ‘investment companies’ for that reason.
Being closed-ended means that all of their shares are created at the inception of the fund. New shares can be issued, but this is a much less common event than the daily creation and redemption of shares that occurs in open-ended funds, and is done to raise additional capital to invest rather than to manage the pricing of the fund.
The upshot is that the price of an investment trust is determined entirely by demand for its shares (as with shares in a company) rather than the value of its underlying assets (as with open-ended funds).
“Unlike open-ended funds, managers do not have to buy or sell investments simply because investors are putting money in or taking money out,” said Christian Pittard, head of investment trusts at Aberdeen Investments. “That allows them to take a genuinely long-term approach and makes investment trusts especially well suited to less liquid assets such as infrastructure, real estate and private companies.”
It also means investment trusts can trade at a discount or a premium to their NAV. Some investors see this as a drawback, especially if discounts sustain over time, but it can mean that investors effectively buy the underlying assets at less than their market rate.
As limited companies in their own right, they can also use leverage – known as ‘gearing’ – to amplify their investment returns. “Borrowing can enhance returns over time by increasing market exposure. For investors who believe in the long-term growth potential of businesses and stock markets, that flexibility can be a significant advantage,” said Pittard.
However, Pittard warned that gearing can also magnify losses when markets fall. “That’s why investment trusts are generally best suited to investors with a long-term perspective who are prepared to look through periods of market volatility,” he said.
Investment trusts can also reserve up to 15% of their returns on any given year and use these to top-up dividends in future years, enabling them to offer investors a smoother dividend yield over the long term.
What’s the difference between active and passive investment funds?
Another way of categorising investment funds is into passive versus active. In brief, active funds have a manager who actively buys and sells securities to try to generate market-beating returns, while a passive fund simply tracks an index (such as the FTSE 100).
Investment trusts are always active funds. Broadly speaking, mutual funds and ETFs can be either active or passive. ETFs are generally associated with passive investing but as above, nothing in the ETF structure mandates this, and active ETFs are growing in popularity.
Active ETFs are managed by an expert portfolio management and research team making forward-looking investment decisions, says Rahul Bhushan, managing director at ARK Investment Management. ARK’s team, for example, focuses on companies in high-growth sectors that it believes will benefit from technological innovation.
“In fast-moving sectors like AI, robotics, blockchain, energy storage and multiomics, we believe active management can be a significant advantage,” Bhushan add
What should investors look for in an investment fund?
The first consideration when choosing a fund to invest in is your risk tolerance and how the fund reflects that.
Seager-Scott says “a common and sensible approach is to think about an asset allocation framework that matches your risk profile,” which effectively means the balance between equities (shares in companies) and bonds – higher-risk and lower-risk respectively.
Similarly, you’ll want to think about what you’re gaining exposure to when buying the fund. Do you want exposure to global equities in all industries, or are you looking to buy into a specific sector? There are funds for each of these and everything in between.
After identifying the kind of fund you want to buy you’ll likely still be presented with multiple options from different providers. Fee levels, as well as the fund’s underlying strategy, can help you decide which is your best option.
Fees can eat into your overall returns so it’s important to understand them.
Active funds typically charge higher fees than passive funds, because it is more labour-intensive to run an active fund than a passive fund. In theory, this is compensated by superior returns, but that doesn’t always transpire: AJ Bell’s latest Manager versus Machine report found that less than half (42%) of active funds outperformed passive counterparts in the first half of 2026.
So before buying an active fund it is important to check its annual returns over the long term and ideally compare these to a passive fund or index in the same sector to ensure that the manager is worth the extra fees. Past returns of course do not guarantee future results, but a track record of outperformance is one indicator of a skilled investment manager.
Investors will also want to check their own understanding of how the index works (for a passive fund) or the fund manager’s strategy (for an active fund) before investing
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Dan is a financial journalist who, prior to joining MoneyWeek, spent five years writing for OPTO, an investment magazine focused on growth and technology stocks, ETFs and thematic investing.
Before becoming a writer, Dan spent six years working in talent acquisition in the tech sector, including for credit scoring start-up ClearScore where he first developed an interest in personal finance.
Dan studied Social Anthropology and Management at Sidney Sussex College and the Judge Business School, Cambridge University. Outside finance, he also enjoys travel writing, and has edited two published travel books.