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.
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.
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 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.
Investment funds that invest in other investment funds from a wide range of asset managers and are often referred to as funds of funds. Some multi-manager funds only invest in the funds of the investment house providing the fund of funds and these are known as “fettered”. An “unfettered” multi-manager fund is free to invest in what the fund manager believes are the top performing funds from across different markets and industries. Investing in multi-manager funds means your risks are spread across geographical regions and industry sectors but it also adds another layer of charges and some multi-managers also levy an out-performance fee.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.