How these funds work
Managed funds and ETFs are a portfolio of assets (kinds of investments) that are chosen by a fund manager. This makes it a good way to get started, as they research and select the investments for you. These funds are typically diversified from your very first dollar, which makes it much easier to spread your risk compared to picking individual shares.
Some funds (managed funds or ETFs) are set up to automatically follow a benchmark index like the S&P/NZ 50 or the S&P 500. These are called ‘index’ funds. The fund manager typically sets up the fund to follow the index by buying and holding company shares to match the index, but then is more ‘hands off’.
From the investors’ perspective, managed funds and ETFs are pretty much the same, as they are pools of investments held on investors’ behalf. The value of a managed fund is typically calculated only at the end of the day. ETFs are a bit different in that the units of the fund, which is what an investor owns, are listed on an exchange. (See below for more on units.) They can be bought and sold throughout a trading day, so their value is determined by what investors are willing to pay for them at a particular time of day.
Why your fund balance goes up… and down
When you put money into a fund, you’re buying units. Units are a way of keeping track of what we own in that fund. These units are linked to the assets our fund has invested in, such as shares, commercial property or bonds.
Think of the fund and its underlying investments like a big fat orange – and our units as a segment of that. When the orange rises or falls in value, so does the value of our segment.
Unlike a savings account, where we’re setting money aside, in funds we are buying things that have value. That orange can be priced higher on the market at some times, lower at others.
When we look at a savings account balance, we rightly think about how much we have. Not so with our fund balance. When we look at that, what we’re really seeing is how much our fund’s investments and our corresponding units are worth – what their value is right now.
Instead of asking ourselves how much we have in a fund, we should be asking, “How much is my fund worth at the moment?” Might be higher, might be lower. Investment returns can be positive or negative.
The value of your units will often rise over time, giving you a return and growing your money (a capital gain). But there is always the risk that their value can drop below what you paid for them. The investments in the fund become worth more or less as markets go up and down, which means our balance will follow suit.
Especially over the long-term, fund values are generally expected to grow. So the idea is to stay in for the long term and ride out any ups and downs. When markets are down, it can feel like you’re losing money, but it’s only on paper. The loss only becomes real if you panic and suddenly withdraw your money.