Contributing to an investment fund can be an effective way to generate extra income. An investment fund is where multiple people pool money and other capital together to invest in stocks, businesses or more.
When contributing to a fund, you can hold either accumulation or income units. These will affect how your funds perform, so it’s important to understand their differences and how they impact your shares. Each type of investment fund will suit a particular financial situation more than the other, so you need to choose wisely to get the best out of your funds.
How do investment funds work?
Investment funds can be pretty complicated for those new to investing, so it’s essential to research them before investing yourself.
When you join an investment fund, you will buy shares that make up that fund. As the fund grows, the value of those shares may increase, allowing you to sell them for a profit.
When you buy into an investment fund, you will have no direct control over how the fund is used. Instead, a fund manager will buy, hold or sell investments on your behalf.
There are two main types of funds that you can contribute to: an ‘open-ended’ fund and a ‘closed-ended’ fund. These have a couple of differences:
With an open-ended fund, there aren’t any restrictions on the number of units or shares that can be issued. So when a new investor comes in, more units are created and are deleted when they sell.
With a closed-ended fund, there is a defined limit to the number of shares it can have. This means that a person can only join a fund if a current member sells their shares to this person.
Both types of funds allow you to contribute to it via income or accumulation units.
What’s the difference between the units?
When you set up the shares in your fund via the income version, any profit that your fund generates is paid directly into your bank account. This can create a regular income stream, which is useful for those that need consistent access to money.
Accumulation funds automatically reinvest your profits to acquire more shares in the fund. This means your stake in the fund increases, and your profit should rise exponentially over time as long as the fund performs well.
This is because when using accumulation funds, the income that you reinvest will start to compound. This means that you generate income on your previous income, resulting in a larger amount of capital being placed into your fund.
Are income or accumulation funds safer?
All investments inevitably involve some risk. Profit cannot be guaranteed, and the fund’s value can increase or decrease. The intrinsic risk of these types of funds is almost equal since your money’s safety essentially depends on what the fund invests in.
Both accumulation and income funds restrict your risk by pooling your money with other investors. This raises their purchasing power so the fund can invest in a wider range of assets.
Should you choose income or accumulation?
The type of fund that best suits you will depend on your current financial situation. If you’re in a position where it will benefit you to have a regular income stream, then an income fund would be better, as it guarantees a regular income.
This type of fund is utilised a lot by retired people to supplement their pension and give them extra spending money, as one example.
If you’re in a position where you don’t need immediate cash, then an accumulation fund could be more beneficial. By reinvesting your income over a longer time, you’ll be able to generate a more significant amount of profit, providing that the value of your fund’s investments rises.
Be aware that if your fund begins to perform poorly, you’ll have contributed more money to your fund via the accumulation method.
When buying shares in a fund, you don’t have to stick with one type of unit throughout the duration of the time that you own them. Instead, you can switch between income and accumulation types so that the fund always performs for your best interests.
Investment funds have the potential to be a great source of income, especially as they allow for a broader scope of investment opportunities. When starting to contribute to one, be sure to understand income and accumulation units and use the most appropriate type for your financial goals and needs.
Remember: As long as the fund continues to make a profit, the value of your individual shares in your investment funds will increase too, so you could eventually sell them for a profit.