How to choose the best investment funds
Over the past 20 years the FTSE 100 has risen at a rate of 5.5% per annum. During the same period inflation has averaged around 4%, making investing in equities very appealing if you want your investment to stay ahead of inflation.
Obviously, investing directly in equities through individual company shares can be a tricky and risky business needing more expertise and analysis beyond that of the average time strapped DIY investor. An alternative to buying individual shares is to buy funds that can spread investment risk across a whole range of company shares and even different asset classes.
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What are investment funds?
Funds are pooled investments that invest in equities, bonds or other funds. The idea is that a fund spreading investments across a number of areas will lessen the impact of any single investment area underperforming, and therefore reduce the risk to the investor.
Most funds will have a fund manager who will have a high level of experience and expertise in investing over a period of time and aim to gain a good return for their investors. Unfortunately not all funds succeed in this aim, so any DIY investor should carry out their own research or engage the services of a financial adviser to ensure any investments are in line with their aims and attitude to risk.
All funds will charge the investor for using their investment expertise and average around 0.75% of total invested every year. These charges can be reduced by researching low cost investment platforms or asking your financial adviser to do this for you.
Choosing the fund
With more than 2,000 investment funds on offer selecting the right fund, or funds, that will be best for your circumstances can be a tricky process.
There are a number of issues you need to consider when selecting your funds:
Before you start looking at individual funds you need to consider how much risk you are prepared to take with your investment.
- investing in equities will always carry an element of risk but this risk can be minimised by investing in established markets with lower volatility levels
- aiming for high returns will require taking a greater risk with your investment
- the greater the risk the more likely you are to lose some or all of your capital
- if you are investing over a short term may need access to your capital at short notice that a low risk investment would be advisable
- if your investment horizons are longer then a higher level of risk could be taken as your investments will have a longer period to recover if they experience a setback
It is important to be clear about your attitude to risk and make sure that all your investment decisions are in line with this. There are a number of resources available that will screen funds by volatility to help narrow down your search.
Income or growth?
What is the aim of your investment? Is it to provide a regular income or are you looking to protect and grow your capital? This decision will decide which types of funds you will need to consider for your investment.
- If you are looking to provide an income then you should invest in income funds where the underlying equities provide income through the payment of dividends. These underlying equities are normally of more mature companies with slower growth but consistent profits, part of which they pay out in dividends.
- If growth is your main investment aim then growth funds would be more relevant as these funds tend to invest in companies who have strong growth prospects, with a share price growth to match.
- It is possible that growth funds will still invest in companies paying good dividends because if these are reinvested can produce good long term fund growth.
- All funds will charge investors for the access to their expertise and the cost of operating the fund, this yearly charge averages around 0.75% of your investment.
- Although this Annual Management Charge (AMC) appears to be on the low side as a percentage it can quickly mount up if you are investing a sizeable sum over a long period.
- Further charges can be made for things like auditor and accountancy fees which could amount to a further 0.1% on top of the AMC. This charge is taken directly from the fund and must be published by the fund manager annually.
- If you employ the services of a financial adviser then you will usually have to pay a further fee of between 0.5% and 1% a year, in addition to any initial fees agreed to carry out a fund review.
- Asset allocation is about spreading your investment across a number of asset classes to minimise the risks involved.
- Including in your portfolio asset classes that act differently in a variety of market conditions will add a 'balance' to your investments and hopefully create a more consistent return.
- Getting the right asset allocation for your circumstances will depend on your age, investment aims and timescales involved.
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