What is an investment fund?

By Stephen Evans

Too many people don't know how to save to maximise their returns while keeping their money safe. There needs to be education around the world if our personal financial futures are to be secured, particularly as regards our pensions.

This was one of the key messages of the opening session of the two-day conference by the Association of the Luxembourg Fund Industry on September 15.

So, here is a basic explanation of the investment fund (also known as a mutual fund).

What is an investment fund?

There is risk in every investment because you never know when it might go bad. Funds seek to avoid this risk by investing in dozens of different companies and countries at the same time. So where one country or part of an economy might be doing badly, then this can be compensated for by growth elsewhere. Customers buy into this and, generally this gives them higher returns over the long-term than bank deposit accounts.

This sounds too good to be true?

Yes and no. You have to pay fees to the firms that organise and run these funds. Customers pay for this service up-front and annually on the funds held. Normally the funds make sufficient profits to cover these costs. You are entitled to know the fees charged for each fund and your fund retailer will supply you with a document about this and other useful information.

So this is a way to get rich quick?

Unlikely. Funds are designed for long-term savings. It's generally best to buy a few funds to cover different investment strategies and hold them for several years. Earnings made by the fund can then be reinvested, meaning you get interest on your interest. Some very clever/lucky people get rich quick. For the rest of us, there is little option to working away and building up savings gradually.

So I should put all my money into funds?

You need balance. Ideally you would have funds that might invest in different countries, different industries, and different underlying securities (mainly shares and bonds (which are loans to companies and governments)). But you might also want some property investment (normally your home), a pension fund (especially as you get tax breaks for these in Luxembourg), life insurance, and money in the bank.

Why should we bother?

State pensions are very generous in Luxembourg, but most economists think this system could start to run out of money one day. Other countries have similar “demographic time bombs”, so if you want a good income in your retirement, maybe you wouldn't want to rely completely on the state to provide.

Do funds have other uses?

Funds attract money that allow firms and governments to invest for future growth. Carlos Doherty, CEO of the Brazilian Financial and Capital Markets Association told the conference that in his country they fund 45% of national debt and 35% of businesses debt. There is a similar story in other countries.

Who needs to be educated about funds?

Everybody. Alexander Schindler, President, European Fund and Asset Management Association pointed out that as well as savers, government and regulators need to know what investment funds are about. This is because too much bad regulation could damage this vitally important industry.

What has this got to do with Luxembourg?

This country has the second largest fund industry in the world. Thanks to the ability to understand different languages, cultures, legal systems, tax codes etc. funds can be based here and sold across borders, mainly in Europe but increasingly in Asia and South America. Key to this are the flexible, well-known fund regulations designed by the EU. The Luxembourg industry is booming at the moment as investors around the world look to make the most from their savings.

Others are looking to muscle in

Already Dublin is a competitor in Europe, and there are moves in Asia to set up a similar regulatory system to that in the EU. This way Asian funds would avoid having to set up in Luxembourg to sell to Asian clients. Sally Wong, CEO, Hong Kong Investment Funds Association said that the regional groupings APEC and ASEAN are getting organised, and may be able to introduce EU-style regulations in a couple of years time.

How can I find out more?

ALFI has produced the understandinginvesting.org website which, in simple language, explains funds and how to use them. 

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