Choosing investment funds
How to choose investment funds
Investments like ISAs or bonds will involve investing in funds, a pool of money which is professionally managed. There are thousands of different funds you could invest in. When selecting funds, think about your investment goals and your attitude to risk.
There are four main steps to choosing funds to invest in for your pension:
- Understand your needs
Key things you need to think about are your goals, your attitude to risk, and your timeframe.
- Decide on a type of fund
Different funds have different objectives, so it's important to invest in those that will help to achieve your goals.
- Narrow down your choice
You can narrow down your fund choice further by comparing features such as volatility ratings and charges.
- Spread your risk
Investing in a range of different asset classes can help smooth out the ups and downs of financial markets over the long term.
Before you start, you should be clear why you’re investing and how much risk you're comfortable taking. Think about:
There are many ways to compare funds.
Most funds invest across four main asset classes, which are:
Equities (shares) – part ownership in a company.
Bonds – essentially loans to a government or company.
Property – direct investments in buildings and land, as well as indirect investments such as shares in property companies.
Money market instruments (including cash) – deposits with banks and building societies, as well as governments and large corporations, and other investments that can have more risk and return than deposits, such as certificates of deposit and floating rate notes.
There are also investments that don't fit into one of these asset class categories. They include direct and indirect investments in real assets like commodities, for example oil or precious metal. They also include investments with specialist characteristics.
As well as choosing to invest by asset class, for example in an equity fund or a bond fund, you can invest in a fund which includes a mix of asset classes. You can also choose to invest by asset class in a specific location, for example a UK property fund or a European equity fund.
Another option is to invest according to an investment style or objective. There are a number of alternatives, including:
Income or growth
Most funds look to make money for investors, but income and growth funds aim to achieve this in different ways. While growth funds invest in assets which aim to increase in value over time, income funds invest in assets which focus on producing a steady stream of income, such as through equity dividends, bond yields and property rental income.
Please note that any income generated within insured (life and pension) funds is reinvested in the funds rather than paid out to investors.
Passive or active
A passive fund aims, before charges, to track or replicate the performance of an index (such as the FTSE 100) rather than trying to outperform it.
An actively managed fund aims to achieve returns that are above average, using fund manager expertise and experience to identify investments with the potential to outperform.
There's no guarantee that actively managed funds will outperform passive funds. They can also be more volatile. Additionally, the research and analysis required means actively managed funds tend to be more expensive than passive funds.
Ethical and Shariah funds
You might want to invest according to your beliefs. Funds like ethical and Shariah funds invest your money according to specific selection criteria. As an example, an ethical fund might avoid investment in companies that are involved in weapons manufacture, tobacco products, gambling and nuclear power.
Some funds give you exposure to a particular sector such as technology, telecoms or natural resources. These can offer the potential for strong performance but, the more specialised your fund, the more risk you take as all of the money you have invested in that particular fund is completely exposed to one sector.
Here are some factors to consider when researching and comparing individual funds:
You can use risk or volatility ratings to help you choose funds most appropriate for your attitude to risk. In general, funds with a higher level of risk or volatility have the potential for higher returns over the longer term. But they are also more likely to suddenly fall or rise in value.
Past performance can tell you how a fund has performed. Some funds can also be compared against the performance of similar funds or a market index. But often it's more relevant to consider how a fund has performed against its aims and objectives.
Remember, even good past performance is not a guarantee of future performance. As with any investment the value of your fund can go up or down and may be worth less than what was paid in.
To spread your risk, you should consider having a portfolio which invests in a broad spread of asset classes. Then you won't need to rely on the performance of a single investment or asset class.
You can build your own portfolio by investing in a number of funds or you can use one of these options to get diversification within a single fund: