How do funds make money? Unlocking the wealth secret for small investors

If you’re a working professional with limited time and want to invest steadily, funds are definitely a worthwhile option to consider. Funds are called the “lazy investment method” because they allow you to earn returns without in-depth market research, thanks to professional management. So, how do funds make money? What is their operating logic? This article will comprehensively explain the secrets of fund investing, from capital flow, fund types, portfolio allocation to cost calculation.

The Core Logic of Fund Profits: Capital Flow and Operating Mechanism

First, we need to understand the basic concept of funds. A fund refers to a collective investment method where investors’ capital is pooled through issuing fund units and entrusted to professional fund managers for investment, with third-party institutions like banks or brokerages acting as custodians to safeguard assets. Simply put, a fund pools money from many small investors and uses professional strategies to invest collectively, allowing each investor to share in the investment gains.

How do funds make money? The entire process involves three core participants: investors, fund managers, and custodian banks. Investors provide capital to the fund company, which makes investment decisions based on the fund’s strategy. The custodian bank then invests these funds into stocks, bonds, money markets, and other assets to earn interest, dividends, or capital gains. When these investments generate returns, they are distributed proportionally to each investor’s holdings.

For example: Suppose 100 investors each invest NT$10,000 into a stock fund. The fund manager uses this NT$1 million to buy selected quality stocks. When these stocks rise or pay dividends, the fund’s net asset value increases, allowing investors to profit from capital gains or dividends.

Comparing Five Major Fund Types: Choosing the Right Investment Tool

Different types of funds vary greatly in their target assets, risk levels, and expected returns. Understanding each fund’s characteristics is the first step to choosing the most suitable one.

Money Market Funds are the lowest-risk type, mainly investing in short-term bonds, commercial paper, and bank deposits. They are highly liquid and can be redeemed at any time, making them suitable for conservative investors prioritizing capital safety and avoiding risk. The downside is that long-term yields are usually low, making significant asset appreciation difficult.

Bond Funds focus on investing in fixed-income products like government bonds, treasury bonds, and corporate bonds. Compared to money market funds, bond funds offer slightly higher returns but require a longer investment horizon to see substantial gains. Their risk is moderate, and liquidity is relatively good.

Index Funds have become popular passive investment tools in recent years. They track specific market indices (such as stock indices or commodity indices) by purchasing all or some of the index’s constituent stocks, aiming to mirror the index’s performance. ETFs (Exchange-Traded Funds) are a common example of index funds. The advantages of index funds include lower management fees and good liquidity.

Stock Funds primarily invest in stocks, representing a higher-risk but potentially higher-return fund type. Suitable for investors willing to accept higher risk and pursue long-term growth. Be aware that stock funds are affected by stock market volatility and may experience short-term losses.

Hybrid Funds invest in a mix of stocks, bonds, and other assets to balance risk and return. Their risk level is between stock and bond funds, making them suitable for moderate risk-takers and offering good diversification.

Below is a detailed comparison table of the five fund types:

Building a Personalized Investment Portfolio: The Golden Ratio of Risk and Return

The key is to tailor your portfolio based on your financial situation and risk tolerance. Avoid putting all your funds into a single fund; instead, allocate different types of funds reasonably to control overall risk while pursuing steady growth.

Depending on your risk preference, consider the following allocation schemes:

Aggressive Investors (young, long investment horizon, able to tolerate volatility): 50% stocks, 25% bonds, 15% money market, 10% others. This setup emphasizes growth, suitable for those seeking asset appreciation.

Moderate Investors (medium risk tolerance): 35% stocks, 40% bonds, 20% money market, 5% others. This balances returns and safety.

Conservative Investors (close to retirement, high cash needs): 20% stocks, 20% bonds, 60% money market. This minimizes risk and ensures capital safety.

The core principle of portfolio allocation is “don’t put all your eggs in one basket.” When one fund performs poorly, the stability of others can offset losses, helping achieve long-term steady returns.

Dissecting Fund Investment Costs: From Purchase to Redemption

Investing in funds isn’t entirely cost-free. Throughout the cycle—from buying, holding, to redeeming—you’ll incur various fees. Understanding these costs allows for precise calculation of actual returns.

Purchase Fees are the most direct costs. When buying a fund, a certain percentage of the purchase amount is charged as a fee—about 1.5% for bond funds and around 3% for stock funds. Sometimes, discounts are available when purchasing directly through brokers or fund companies.

Redemption Fees can be more complex. In Taiwan, most funds do not charge redemption fees, but banks often deduct a “trust management fee” from the net asset value upon redemption, typically around 0.2% annually. This fee applies mainly to certain money trust funds purchased via banks.

Management Fees are charged by fund companies for asset management, covering salaries and research costs. These usually range from 1% to 2.5% annually, with ETFs and index funds generally having lower fees (below 0.5%).

Custodian Fees are charged by the custodian bank for safekeeping assets, about 0.2% annually. Since fund companies do not directly hold the assets, this fee is necessary.

Though these fees may seem small, they accumulate over time and can significantly impact investment returns. Choosing funds and channels with lower costs can greatly enhance final gains.

Why Choose Funds? Core Advantages Over Other Financial Tools

Compared to direct stock investments or other financial products, funds offer several key advantages, which explain why more investors are turning to them for wealth management.

Diversification is the most important benefit. Funds invest across multiple assets and stocks, reducing the impact of a single stock’s decline on the overall portfolio. This diversification significantly lowers unsystematic risk.

Professional Management is invaluable. Fund managers possess deep market knowledge, industry research skills, and practical experience, allowing them to adjust strategies according to market changes, helping investors avoid risks and seize opportunities. For busy professionals without time for market research, this is a major advantage.

Liquidity means you can buy or sell fund units at any time. Unlike real estate or long-term contracts, funds typically settle within a few trading days, making capital more accessible.

Low Investment Threshold allows more people to participate. Most funds permit investments starting from NT$3,000, making them friendly for small investors or beginners.

Long-term Steady Growth is the core advantage. Funds are suitable for medium- to long-term investment, leveraging compound interest. As long as you stick to a long-term plan, even with short-term market fluctuations, you can often achieve good returns over time.

In summary, funds have become an essential tool in modern wealth management because they combine risk management, professional management, ease of operation, and low entry barriers. If you want to start your investment journey through funds, first assess your risk tolerance, choose suitable fund types, and allocate your capital following the principles outlined here. Remember, the key to making money with funds is not short-term surges but long-term persistence and proper allocation.