By DIY Investor
April 8, 2020
With over 3,000 funds to choose from, how do you know which ones to invest in? First, think about these three key questions:
Are you planning to use dividends to provide an income, or are you looking to grow your capital? These decisions will often depend on which life stage you are at, perhaps you want to supplement other retirement income or are you saving for a rainy day? Read more about investing outcomes here.
There is a trade-off between risk and reward; it is generally assumed that the more risk you are prepared to take, the higher the potential returns, whereas if you are very cautious with your investments, you can anticipate lower returns.
Importantly, don’t risk what you can’t afford to lose.
Received wisdom is that the longer the time frame you have to hold your investments, the more risk you might be able to take on, as there is potentially opportunity to ride out some of the inevitable peaks and troughs of stock market performance.
As you are selecting a fund, you will already have a level of diversification (as the fund will hold multiple individual company shares or different types of investment vehicle), however, it is important that you consider increasing this. Greater diversification should help reduce risk.
If you are invested in one particular sector which is impacted by events and the value of company shares in that sector falls, you are overly exposed to that risk. Whereas, if you have spread your investments across different sectors, you will have also spread your risk and reduced the impact of a sector underperforming.
Add up all the assets you have across equities, fixed interest, property and cash and work out what the percentage split is to give you your ‘asset allocation’.
Think again about what your investment goals are and to what degree these are currently being met.
There’s an old rule of thumb which suggests you should subtract your age from 100 and the difference should be the percentage of your portfolio that you hold in equities. So if you are 55, around 45% of your assets should be held in stocks and shares.
Now that people are living longer and need a greater accumulation of capital, you could consider subtracting from 110 or even 120. There is then longer to take advantage of the potentially higher returns that shares offer.
The Investment Association, the trade body that represents UK investment managers, splits funds into different sectors and most fund names will reflect the area or type of investment.
Reflecting what your investment goals might be, funds fall broadly into two categories; those that aim to produce income and those that aim for capital growth.
The next level of classification is the type of asset (e.g. shares, fixed income), geographic region or industry sector in which the fund invests.
Some funds sit in sectors focused on capital protection, such as money market funds, or are in the specialist category, and some choose to remain unclassified.
The targeted absolute return sector contains funds that aim to produce positive returns in all market conditions.
If you are starting out, you might want to consider a global fund, the ultimate in diversification, as this will give you broad exposure to different markets and you don’t have to make choices as to how to split your investments. There are also funds that invest in the UK too.
Generally speaking, the narrower the fund’s investment objective, the more specialist it is and therefore the less diversified.
Another aspect worth considering is whether you would prefer to select a passive fund, like a tracker or Exchange Traded Fund (ETF), which follow an index or an actively managed fund, where the fund manager is making the decisions about which companies or investment vehicles to invest in. This is not necessarily an either-or choice. Following the diversification argument, you might choose to have a mix of passive and active funds in your portfolio.
If you have an idea of which sectors you want to invest in, you'll find there are usually many funds belonging to the same sector. Websites like FE Trustnet and Morningstar provide a wealth of information, including factsheets on each of the funds, ratings and risk/return analysis.
If you are using an investment platform, this will also provide research and information on the different funds available. Some platforms also set up model portfolios, which can offer some good ideas on how to combine fund selections to achieve your investment goals.
How do you know where to start when there are so many funds to choose from? Start with just three, aligned to your appetite for risk.
We've added new fund lists for experienced investors, so whether you're looking to invest in Emerging Markets, US equities or ethical funds, we've got three starter funds to choose from.
This article has been updated and was originally published in March 2019, written by Georgette Harrison, contributor to Focus on Funds magazine.
The views and opinions expressed by the author, Focus on Funds magazine or associated third parties may not necessarily represent views expressed or reflected by EQi. The content in Focus on Funds magazine is non-partisan and we receive no commissions or incentives from anything featured in the magazine.
The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance.
Focus on Funds Magazine delivers education and information, it does not offer advice. Copyright© DIY Investor (2016) Ltd, Registered in England and Wales. No. 9978366 Registered office: Mill Barn, Mill Lane, Chiddingstone, Kent TN8 7AA.