BLOG: Three good reasons (and one terrible reason) to buy a fund
Choice is a good thing, but choosing an investment fund from the thousands on the UK market can be daunting.
Here are three simple guidelines to follow when making a selection.
The first good reason to buy is the most important: choose a fund because its risk level is right for your goals. That means that you’ve first identified what you want to achieve as an investor.
A vague notion that you want “high returns” isn’t enough. You need to have an idea of your long-term objectives, and only take as much risk as you need to get there.
Try to find out what a typical year’s performance from the fund’s main asset class might look like. Is this fund looking at shares, bonds, property, commodities or a blend of assets? What about good years, or bad years? All asset classes have long-term expected returns, and although they do change a little over time they are remarkably stable in the long term.
A smart investor knows that returns aren’t predictable year-to year and doesn’t try to game the market in the short term. Instead, they have discipline, tunnel vision and a clear idea of what success looks like for them.
With the risk level matched to your goals, the next good reason to choose a fund is that its style suits your personal preferences. Is this a very actively managed fund? Is it an index tracker? An income fund? Or an ethical fund? Is it one of the new “smart beta” products coming to market? All of these different flavours have their merits; one will be the best fit for your investor personality.
“Style” can also mean the areas of focus each fund takes within its asset class. An equity fund, for example, might focus on larger or smaller companies, or it might have a value or growth bias. A bond fund might focus on the very highest quality companies, or on the weaker “high-yield” end. All of these style decisions feed back into the overall risk level of the fund. All funds within an asset class are not equal.
Lastly, take a good look at what this fund wants you to pay. Every penny they deduct in charges will reduce your returns. You need to be sure that you know exactly what you’re paying for, what the benefits are, and that you couldn’t find better value elsewhere.
This doesn’t mean that you should only look at low-cost index trackers. The debate about active vs. passive is often reduced to a simple cost argument when, in truth, it’s more complicated. There are times when it’s wise to track, and times when it’s better to pay extra for an active manager. Both camps try hard to debunk each other, but don’t let anyone tell you that there’s only one way to invest.
The one to avoid
A common mistake made by investors is to be guided- and blinded- by personality.
We’re presented with images of wise, heroic fund management gurus who can generate stellar investment returns through sheer intellectual force. We feel comforted by their carefully-presented track records and their “safe pair of hands” images. It’s all just marketing spin. Although fund managers do have an impact on the return of their funds, it’s usually far less significant than the impact of the three “good reasons to buy” we’ve identified.
If your risk level, style and charges are right for you, then a skilled fund manager is just the cherry on top. But if you ignore the basics of the cake and invest with the cherry at the forefront of your mind, you’ll likely be disappointed.
Time spent thinking about risk, style and charges is always well spent. A goal-based financial planner can help; a fund salesman probably can’t.
Rick Eling is head of investment solutions at Sanlam UK