One of the easiest routes to investing is via pooled funds or investment funds. A particular fund represents a basket of investments composed of different securities and assets. This means that a single account or a single transaction allows an investor to have a diversified investment. Investing in pooled requires a foundational understanding of how it works, the different types of pooled funds available, and their collective advantages and disadvantages or pros and cons.

Definition: What are Pooled Funds and How Do They Work?

Pooled funds are also called investment funds. These investments are called “pooled” because they involve pooling or combining money from different individual investors to create a larger pool of capital that would enable the purchase of substantial amounts of securities or assets. This is how pooled funds work in essence. They can also be called collective investments and they literally translate to funds that are combined together.

The varies term used in other countries varies. Some call them investment pools. Others call them managed funds. They are also called funds by default in most instances. It is important to note that these funds are managed by a team of professional fund managers. Each also has its investment strategy and goals and objectives as defined by its plan rules or prospectus. These funds are also regulated by relevant government agencies.

A fund also represents a basket of investments or different securities and assets. The composition of this fund is based on its investment strategy and goals and objectives. An equity fund, for example, is a pooled fund that is composed of stocks of publicly traded companies while a bond fund is composed of fixed-income securities or bonds issued by corporations and governments. A balanced fund is composed of both stocks and bonds.

Main Types: What are the Different Types of Pooled Funds?

It is also important to underscore the fact that “pooled fund” is a loose term because there are different types of pooled funds or investment vehicles that involve pooling money from different investors. Each has its respective features or defining characteristics, as well as advantages and disadvantages. Not all countries offer these types of pooled funds. However, when it comes to the most common ones, take note of the following:

• Mutual Funds: These are the most common types of pooled funds. Mutual funds are also considered open-ended funds, and investment is represented by the number of units owned by individual investors and the monetary value of each. There is also no maturity in most cases and investors can withdraw a partial or full amount through unit cancelation. They are offered by mutual fund companies, investment firms, and insurance companies.

• Unit Investment Trusts: A unit investment trust or UIT is similar to a mutual fund in general. The main difference is that it is created for a specific length of time and characterized by a passive portfolio that is passively managed. A particular UIT in the United States is also a registered investment company. However, in other countries, they are called unit investment trust funds and are offered by banks and investment firms.

• Exchange-Traded Funds: There are also pooled funds that are traded in stock exchanges like stocks. These are called exchange-traded funds or ETFs. These ETFs are also similar to mutual funds but they can be sold and bought or traded throughout the day. This also makes them a type of security on their own. Most brokerage companies and investment or asset management firms offer a range of ETFs as part of their service offerings.

• Hedge Funds: A hedge fund is also another type of pooled fund that pools capital from a limited number of accredited individual or retail investors and institutional investors. An investor needs to meet certain income or net worth thresholds and aggressive risk profile criteria to become accredited. This makes it more exclusive and limited than retail-focused pooled funds like mutual funds, unit investment trusts, and exchange-traded funds.

• Private Equity Funds: There are also pooled funds that invest in equities of private companies or businesses that are not publicly traded in the stock market. These are called private equity funds. These funds are structured and registered as limited partnerships. They invest in private companies of varied sizes and tenure. These funds have a finite term of around 10 to 12 years. They are also not as liquid as retail-focused pooled funds.

• Real Estate Investment Trusts: A real estate investment trust or REIT is somewhat similar to a UIT. It is registered as a company. REITs essentially are companies that own, operate, or finance productive or income-producing real estate properties. They generate income through renting, leasing, or selling these properties. This allows investors to add real estate to their portfolio without directly purchasing and owning real estate properties.

The definitions of the different types of pooled funds discussed above should be taken into consideration by investors. These definitions represent their defining characteristics or unique features. The consensus is that mutual funds and unit investment trusts are ideal for both beginners and seasoned investors because they are more accessible. Investing in exchange-traded funds and real estate investment trusts is suitable who want to diversify or expand further their portfolios. Both hedge funds and private equity funds are ideal for deep-pocketed investors who are willing to take up higher risks in exchange for higher potential returns.

Pros and Cons: What are the Pros and Cons of Pooled Funds?

Remember that each type of pooled fund has its inherent advantages and disadvantages. However, owing to their similarities, they also share general advantages and disadvantages. These advantages center primarily on the benefits of economies of scale and higher potential for diversification. The disadvantages stem from the fact that investors do not have direct control over the investment decisions of fund managers.

The following are their specific advantages:

• Cost-Effective Investment: One of the main advantages of pooled funds is that they allow investors to invest in a selection of investments at a minimal cost compared to purchasing individual securities and assets. Investing in a hedge fund might be more expensive than other pooled funds but it is still considered more affordable than building a self-directed investment portfolio.

• Investment Diversification: These investments also offer investors with a convenient approach to managing risks through the diversification of investments. Remember that each fund represents a basket of investments composed of different securities or assets. Hence, investing in a single fund means investing in multiple securities and assets in a single transaction.

• Professional Management: Investing in pooled funds also comes with the benefits of having a team of professional fund managers. There is no need for an individual investor to think of strategies. Each fund has its investment goals and objectives and an investment strategy to achieve them. Investors only need to ensure that the fund is aligned with his or her goals and objectives.

• Benefits of Economies of Scale: Remember that economies of scale make these pooled funds affordable to most investors. It is also worth noting that another more specific advantage of pooled funds is that the larger pool of capital provides greater purchasing power, allows fund managers to negotiate associated fees, and enables access to investments that might be out of reach for most.

The following are the specific disadvantages:

• Lack of Control Over Investment: One of the main disadvantages of investing in pooled funds is that a particular investor does not have control over the choices of securities and assets, as well as their allocations. The performance of their investments rests on the decisions and capabilities of the fund managers. This might be unsuitable for investors who prefer a self-directed approach.

• Potential for Underperformance: It is also worth mentioning that not all pooled funds will either perform the same way as the benchmarks in the financial markets or outperform these markets. There are different factors at play. Overdiversification risks diluting the gains from high-performing securities or assets. The decisions of the fund managers are also not always optimal.

• Exposure to Marker Risks: These investments also have risks. The type of risks depends on their composition. Funds that are invested in stocks are exposed to risk inherent to stock investing and those invested in bonds share the risks of bond investing. ETFs have price volatility risk. Mutual funds and UITs can suffer from missed chances that come from intraday price movements.

• Notable Associated Costs or Fees: It is true that investing in retail-focused pooled funds is more cost-effective in general. Investors should still be aware of the costs involved. These include operational expenses, specific management fees, commissions or sales costs, and transaction fees, among others. Fund activities and performance might also generate tax consequences.