Behavioural finance has an increasingly central part in conversations about investment risk, since managing emotional responses plays a key role in maximising returns.
Funds are one of the most common investments sought, read our quick guide to funds and know what to look for.
A fund is an investment vehicle which a group of investors hold in common: their money is pooled to purchase stocks, bonds or other assets (most often by a professional investment manager). These vehicles often exploit the talent of a particular fund manager or team by specialising in investing in a particular region or asset class. They may even get as granular as a particular sector, such as funds which buy equities of luxury goods manufacturers.
Funds are regulated in how they operate and how they are marketed to investors. They are an efficient way to invest a moderate sum in different assets and thereby improve the diversification of your investment portfolio. They also typically offer investors both income and capital gains.
When you purchase shares of a fund, its investment management team will use this money to purchase a proportionate amount of the fund’s underlying stocks or bonds. The fund will then pay you a proportion of the income earned on the assets, as well as a share of its capital gains from selling assets. It is also possible to make money on a fund if you sell your units at a profit.
Your wealth manager will help you select investment funds which are a good fit with the rest of the assets you own, in terms of achieving your financial goals and diversification – so that all your investments don’t fall at the same time in adverse market conditions.
Funds are categorised according to three main criteria: the assets they principally invest in, the liquidity they offer and whether or not they track a market index. The three main asset categories are the money market, bonds (fixed income) and stocks, with some funds operating as a hybrid of these by investing in a mixture of asset classes.
Money market funds are often associated with the most risk, while fixed income investment funds hold out a more stable (but often lower return) alternative. If you are investing in the very long term, such as for retirement, equities may be the best option to consider since you will have plenty of time to recoup any losses you may experience.
Funds also have three main liquidity categories: open-ended, unit investment and closed-ended. An open-ended model offers the most liquidity, as shares can be sold back to the fund at the end of every business day. It is crucial to consider how much liquidity you need in a fund.
Funds are also split on whether they are index tracking or actively managed. Index-tracking funds will reflect the value of a typical basket of securities, whereas an actively-managed fund will deploy the fund manager’s investment skill to try to beat the market. Actively-managed funds do carry higher fees than index-tracking vehicles and, despite phrases like “absolute return” being common in fund names, they offer no guarantee of the returns aimed for.
A further consideration is that funds offer different share classes to investors, each of which has different expenses and priorities. Your wealth adviser can help you to understand which is best for you.
There are literally thousands of funds available to invest in, and a whole spectrum of investment success too. It can be very difficult for non-professionals to predict how well a fund will do in future by relying on historic performance data and investors can often find themselves buying into a fund which has already “had its day”. It should also be noted that funds often quote outstanding returns, which are sometimes far too good to be true: great returns in one year can hide poor performance over a longer period. That said, wealth managers have entire teams of analysts dedicated to assessing fund performance so that they can offer clients an extensive list of recommended vehicles.
It’s also important to compare the fund’s returns to the market index, and to other similar funds. Your wealth manager can explain the relevance and bias of the performance statistics of a fund.
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