What Are Pooled Funds?

Pooled funds is a generic term for a portfolio of money from many individual investors that are aggregated for the purposes of investment. Mutual funds, hedge funds, exchange-traded funds, pension funds, and unit investment trusts are all examples of professionally managed pooled funds. Investors in pooled funds, benefit from economies of scale, which allow for lower trading costs per dollar of investment, and diversification.

The Basics of Pooled Funds

Groups such as investment clubs, partnerships, and trusts use pooled funds to invest in stocks, bonds, and mutual funds. The pooled investment account lets the investors be treated as a single account holder, enabling them to buy more shares collectively than they could individually, and often for better—discounted—prices.

Mutual funds are among the best-known of pooled funds. Actively managed by professionals, unless they are index funds, they spread their holdings across various investment vehicles, reducing the effect any single or class of securities, has on the overall portfolio. Because mutual funds contain hundreds or thousands of securities, investors are less affected if one security underperforms.

Another type of pooled fund is the unit investment trust. These pooled funds take money from smaller investors to invest in stocks, bonds, and other securities. However, unlike a mutual fund, the unit investment trust does not change its portfolio over the life of the fund and invests for a fixed length of time.

Key Takeaways

  • Pooled funds aggregate capital from a number of individuals, investing as one giant portfolio.
  • Many pooled funds, such as mutual funds and unit investment trusts, are professionally managed.

Advantages of Pooled Funds

With pooled funds, groups of investors can take advantage of opportunities typically available to only large investors. In addition, investors save on transaction costs and further diversify their portfolios. Because funds contain hundreds or thousands of securities, investors are less affected if one security underperforms.

The professional management helps to make sure investors receive the best risk-return tradeoff while aligning with their work with the fund's objectives. This management helps investors who may lack the time and knowledge for handling their own investments entirely. Mutual funds, in particular, offer a range of investment options for the highly aggressive, mildly aggressive and risk-averse investor. Mutual funds allow for the reinvestment of dividends and interest that can purchase additional fund shares. The investor saves money by not paying transaction fees to hold all of the securities contained in the fund's portfolio basket while growing his portfolio.

Pros

  • Diversification lowers risk

  • Economies of scale enhance buying power

  • Professional money management is available

  • Minimum investments are low

Cons

  • Commissions and annual fees are incurred

  • Fund activities may have tax consequences

  • Individual lacks control over investments

  • Diversification can limit upside

Disadvantages of Pooled Funds

When money is pooled into a group fund, the individual investor has less control over the group’s investment decisions than if he were making the decisions alone. Not all group decisions are best for each individual in the group. Also, the group must reach a consensus before deciding what to purchase. When the market is volatile, taking the time and effort to reach an agreement can take away opportunities for quick profits or reducing potential losses.

When investing in a professionally managed fund, an investor gives up control to the money manager running it. In addition, he incurs additional costs in the form of management fees. Charged annually as a percentage of the assets under management (AUM), fees reduce a fund's total return.

Some mutual funds also charge a load or sales charge. Funds will vary on when this fee is billed, but most common are front-end loads—paid at the time of purchase and back-end loads—paid at the time of divesting.

An investor will file and pay taxes on fund distributed capital gains. These profits are spread evenly among all investors, sometimes at the expense of new shareholders who did not get a chance to benefit over time from the sold holdings.

If the fund sells holdings often, capital gains distributions could happen annually, increasing an investor’s taxable income.