World 9 · Investing & wealth building · Lesson 9 of 16

Funds and ETFs

Pooling money with many others to own a spread of investments at once.

7 min read · Level: Practical · Free — no account needed to read

The idea

A fund pools money from many investors and invests it together. Owning part of a fund gives you a share of everything it holds — often hundreds or thousands of shares or bonds — which provides instant diversification that would be hard to achieve alone. Funds are run by managers and charge fees for doing so.

Some funds are actively managed: managers try to choose investments that will do better than the market, and charge more for the effort. Index funds are passive: they simply hold everything in a market index, at low cost. An ETF (exchange-traded fund) is a fund that trades on a stock exchange like a share, and many ETFs are low-cost index funds.

Research over many decades has found that most actively managed funds do not beat comparable index funds after fees over long periods — though some do, and it is hard to know in advance which. This is one of the most discussed questions in investing.

Why it matters

For most people, funds are the practical way to own a diversified investment. Understanding the differences, especially fees, can change outcomes significantly over decades.

A real example

The situation

Aiko is choosing between an actively managed fund with a strong recent record and a low-cost index fund.

What happened

She reads that past performance often does not continue, and compares the yearly fees, which differ several-fold. She chooses based on the fee and on the breadth of what the fund holds, not on recent returns.

The takeaway

She focused on what she could know in advance — cost and breadth — rather than on past results.

How people actually behave

People are drawn to funds that did well recently, assuming the success will continue, and pay less attention to fees because they are small percentages taken quietly.

Common mistakes

• Choosing a fund because of last year’s return.
• Ignoring yearly fees, which compound over time.
• Owning several funds that all hold the same things.

Different perspectives

Reasonable people disagree here. None of these is presented as the answer.

Low-cost index funds suit most people

Supporters point to long-term evidence that most active managers trail comparable indexes after fees, so owning the whole market cheaply is hard to beat.

Active management has a place

Others argue that skilled managers can add value in some markets, manage risk, or avoid bubbles, and that index investing has its own risks when everyone does it.

Questions to think about

• What do you pay each year in fees on any fund or pension you have?
• Do you know what your fund actually holds?

Try it: Read a fund’s key facts

1. Find the key information document for a fund you own or have heard of.
2. Note what it holds, its yearly fee and its risk rating.
3. Compare the fee with a similar index fund’s fee.

Words in this lesson

• Fund — A pool of money from many investors, invested together in many holdings.
• Index fund — A fund that simply holds all the investments in a market index, at low cost, rather than trying to pick winners.
• ETF (exchange-traded fund) — A fund that trades on a stock exchange like a share; many simply track an index at low cost.
• Expense ratio — The yearly fee a fund charges, as a percentage of what you have invested in it.