How to choose the right funds for you

Once you have an idea of how much you can invest, know your risk profile and your timeframe it becomes much easier to narrow down your choice.

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One-stop shop funds

If you don't have a large sum to invest and don't have an aggressive attitude to risk you might like a one-stop shop fund which provides an instant balanced portfolio with investments in cash, fixed interest and equities.

At the lower risk end of the spectrum are funds in the Mixed Investment 0-35% Shares sector, which cap investment in stocks and shares at 35%. Then for balanced or medium risk investors there is the Mixed Investment 20-60% Shares sector, where between 20% and 60% of the fund is invested in shares. Mixed Investment 40-85% Shares is for investors who want their money to be invested across the asset classes but want to maximise returns with greater exposure to equities.

Fund managers can change how much they have invested in different asset classes as economic conditions change, so long as they stay within the sector's agreed parameters.

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Diversify, diversify, diversify

Alternatively, if you want to be fully invested but have money spread across the world you can go for a global fund, with investments in developed and developing economies.

Another way of increasing diversification is to use multi-manager funds where, rather than buying shares of individual companies, the manager buys stakes in other funds. However, because they invest in lots of funds, charges are higher than the typical unit trust, and this can eat into your returns.

If you plan to build your own balanced portfolio of funds you'll have to think a bit more carefully about where to invest. The UK is the obvious entry point for most investors, but there are still a huge variety of funds to choose from.

If you'd like to earn an income from your money – for example, you are in retirement or need to supplement your income - UK equity income funds make sense because the companies they invest in pay regular and reliable dividends. However, even investors wanting to grow their money shouldn't rule out this sector. You can opt to re-invest dividends, which can be an excellent driver of growth.

Over recent years the UK smaller companies sector has produced some fantastic returns – with the best achieving close to 100% over the last three years. But be warned, while the returns have been impressive, smaller companies are much higher risk than the big names of the FTSE 100.

Funds that specialise in the emerging markets and specialist industries such as healthcare and pharmaceuticals are popular and have rewarded investors well over the years but they are at the upper end of the risk spectrum. This means such funds should only be considered by investors who can afford to take a sizeable risk, likewise they should only make up a small portion of your overall portfolio.

Get your bond fix

Within corporate bonds there are few sectors to choose from – you can go for plain old corporate bonds (which must be 80% invested in lower-risk investment grade corporate bonds) or high yield bond funds (which must be 50% invested in riskier higher-yielding bonds).

Strategic bonds have more flexibility to decide which types of bonds they buy (meaning they are better able to adapt to changing economic circumstances) while global corporate bond funds must have 80% of their assets invested overseas.

Fund supermarkets

Fund supermarkets have plenty of tools to help you choose which funds to invest in. Interactive Investor, for example, has a fund filter where you can choose your asset class and the geographic area you want to invest in – whether you want income or growth – and the risk rating you are prepared to accept. You can also factor in performance. This then gives you a shortlist of funds to consider.

When you are researching and comparing funds, performance is the obvious starting point. But don't just look at the last 12 months – go back at least five to seven years as you want to be able to see how performance rises and falls and how the manager copes with changing economic conditions. Don't just look at the fund in isolation either, compare it with other funds in its peer group, or sector.

This information will all be readily available on your fund supermarket's website. Here you will also be able to read fund factsheets which explain more about the aims and goals of the fund, detail its top 10 holdings and provide more information about the fund manager and their career history (for example, if you are impressed by past performance, make sure the current manager is the one that achieved it).

Together, this information will go some way in explaining any differences in the performance of the funds you are considering and will give you a much clearer idea of the fund's strategy before you part with your cash.

If you really can't decide, Interactive Investor also offers ready-made fund selections, specialising in areas including UK Growth, UK Equity Income, Hot Spots, Europe and Fixed Interest.

For more ideas for funds across the investment universe check out the Moneywise Fund Awards 2013.

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