What should you know before buying a fund?
We consider some of the questions you might want to ask before investing in a fund.
What you’ll learn:Click to toggle accordion What you’ll learn:
Why your risk profile matters when choosing a fund.
How diversification works.
Why a multi-asset fund may be a good option.
With thousands of different funds to choose from, picking which ones to invest in can seem a daunting task, particularly if you’re new to investing.
Of course, you’re not limited to investing in funds, with plenty of other assets such as shares and bonds on offer, but when you put money into a fund, it’s spread across a wide range of investments, which helps you to diversify your risk.
Remember that no matter which funds you choose, there are no guarantees of a positive return. Investments may fall in value as well as rise, and you could get back less than you initially invested.
Here, we look at some of the questions you might want to ask yourself when choosing a fund. We don’t offer financial advice, so if you’re unsure where to invest, seek professional advice.
Does the fund match your approach to risk?
There is a vast universe of funds to choose from, catering for different levels of risk. As a general rule, the longer your investment time frame, the more risk you can afford to take as your investment has greater time to recover from stock market setbacks. There are no guarantees, however, and there is always the chance you could get back less than you put in, however long you invest for. The amount of risk you are willing to take is entirely personal, and even if you’re investing over a time period of, say, 20 years, you may still want to take a cautious approach if you fear losing money.
Yet, as with all investments, the greater the potential returns on offer, typically, the higher the risk you take. For example, investing in an emerging market fund that focuses on countries such as India or Brazil will be higher risk than a fund that invests in UK equities, so you’ll need a strong appetite for risk.
It’s important to check that your fund choices match your approach to risk particularly if you are investing in a single fund. However, ideally, whatever your risk tolerance, you will invest in a wide range of investments to spread risk.
Is there any crossover with other investments you hold?
Ideally, you will invest in a wide range of investments to spread risk. By diversifying your investments the hope is that if one or more falls, some of your other holdings in other asset classes will be going up in value. Over the long-term, this can help smooth returns. When choosing a fund, check whether any other investments you hold don’t invest in the same assets, as this could mean you end up focusing too much on one particular area.
You could simplify the process by investing in a multi-asset fund as a ‘one-stop-shop’. This way, you get the diversification of a balanced portfolio within a fund and don’t have to spend your time monitoring a wide range of investments. A multi-asset fund manager will invest in different types of investment on your behalf, and you can choose a fund that suits your risk profile. You could choose one, say, that has a higher proportion invested in equities for greater risk, or, conversely, a smaller proportion in equities if you want to take a cautious approach.
Remember that whatever approach to risk you take, however, there is still the chance you could lose money, and might get back less than you initially invested.
Is the fund passive or active?
When you’re choosing an equity fund, which focuses on shares, you have the choice of two types – passive or active.
A passive fund, which will typically be a tracker or index fund, is one that tracks a market or index, such as the UK’s FTSE 100 Index. They will buy a portion of each of the shares in the index, and aim to mirror its performance. Alternatively, active funds have a fund manager who chooses which shares to buy, in the hope of outperforming a particular market, although there are no guarantees they will achieve this. Investors in actively managed funds will have to pay higher annual charges for the expertise of the fund manager.
What is the fund manager’s track record?
Before investing in a fund, you may want to check that its manager has demonstrated the ability to generate attractive long-term returns. Some managers are renowned for consistently strong performance over many years, making the funds they manage particularly popular among investors. If they are replaced, it may impact on performance.
However, bear in mind that past performance isn’t a guide to the future, and there are no guarantees that a fund manager’s winning streak will continue, as even the best managers make poor decisions sometimes.
What are the charges?
Charges can eat into returns over time, so make sure you’re comfortable with the amount you’re paying. They are an important factor when choosing which fund to invest in.
If you pick an active fund you’ll typically pay an annual fee of between 0.6% and 1.5% of the value of the investment that you hold, which will be higher than for a passive fund. However, the cost will depend on the type of fund you choose, with specialist options such as a technology fund sometimes being more expensive than, for example, a UK equity income fund.
Passive funds, by contrast, have annual charges as low as 0.1%. Again, these may vary depending on the index that is being tracked, and the particular fund you choose.
If you’re unsure where to invest, consider taking professional financial advice. We don’t offer personal financial advice.
Remember, the value of investments can fall as well as rise and you could get back less than you invest. We're not recommending Ready-made Investments as being suitable for you based on your personal circumstances. If you're unsure about this investment’s suitability for you, you should seek independent advice.
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