Don’t put all your eggs in one basket

Do you have a full-time job? Picking stocks and bonds yourself can feel like having two of them. DIY investing often requires an intimate knowledge of capital markets, poring over companies’ annual reports and perhaps even paying exorbitant trading fees.

There is another, simpler and arguably easier way – investing in funds. Funds can take away the hassle, allowing you to keep an eye on your money with a minimal admin-related headache.

Lots of people invest in funds – to the tune of £1 trillion by UK investors as of the end of 2017¹. Economy of scale is a great thing. Pooling your money with other people means lower costs and lower risk. This is because the fund manager has the resources to create a more diversified portfolio, including different asset classes, sectors and geographical regions – areas you might never have thought of or been able to access as an individual investor. And the beauty of having your eggs in different baskets is that while certain stocks or bonds might dip, others may rise, potentially balancing out the overall performance of the fund.

The main decision you need to make is which type of fund, or which combination of funds, is right for you. The three main categories are active funds, index funds and investment trusts.

An active fund involves the fund manager buying and selling stocks and bonds on behalf of his or her clients, aiming to beat the broader market and make a positive return. The manager does detailed due diligence on every holding and can even meet the heads of a company before making a decision on whether to invest in it.

An index fund usually takes one of two forms – an index tracker unit trust or an exchange-traded fund. While there may be differences in their structure, the purpose of all index funds is the same – simply to track a given market, whether it be UK companies or the largest and most liquid bonds. Whichever direction that market goes, so will your fund.

Lastly, the investment trust is another form of active fund and has been around since the 19thCentury. Investors can buy and sell a fixed number of shares in the same way that they can trade shares in individual companies. And like normal shares, their price goes up and down depending on supply and demand and the fortunes of the company concerned.

Here’s where it gets a bit tricky. The unique structure of the investment trust means that when there’s a lot of demand, its share price can climb higher than the value of the underlying securities that the fund invests in. So the trust is trading at a premium. If demand falls, the trust will trade at a discount. Much of the return investors make with investment trusts depends on whether the share price climbs to an even higher premium, or rises from a discount back to net asset value.

Regardless of which fund you choose, there are some basic rules that apply to all of them. One is that there will always be fees to pay, whatever the investor makes by way of return, so it’s important to shop around. Fees vary per fund and are expressed as an “OCF” – ongoing charge figure – in percentage terms. Index funds tend to be cheaper than the actively managed kind because once one has been set up to replicate a particular index there is less ongoing maintenance needed. The manager of an active fund, on the other hand, is constantly evaluating which are the best securities to buy and sell. Similarly, an investment-trust manager is always looking around for the best securities. Ideally both types of active funds will aim for low turnover since trading fees can eat into your returns.

A good way to assess if your fund’s fees are competitive is to compare average costs. These differ depending on the asset class, the geography and the sector you’re investing in – not to mention the fund type. In Europe, an index fund investing in equities typically costs 0.37%². But this varies widely – buying an index fund that focuses on stocks in more esoteric markets in Africa and Asia, for example, will be more expensive because they are less liquid and harder to access, while an index fund that focuses on companies that rank highly in terms of environmental, social and governance factors will also usually cost more than average. The average OCF for an actively managed fund investing in a mixed bag of companies in the UK is 1.40%³, but again many funds will fall below or above this mark. Although past performance does not indicate future returns, it is therefore worth looking at the active manager’s track record and see if they have consistently beaten their benchmarks over time.

Another basic rule is that no investor or fund manager has a crystal ball and can guarantee success, so the more diversified the fund’s holdings and the lower the fee, the more chance the investor has of making a return. Lastly, all investments are designed for the long term and not as a get-rich-quick strategy – so it really is a case of sit back, relax and delegate the full-time job to a professional.

¹ Source: The Investment Association, Asset Management in the UK 2016-2017
² Source: data provided by Thomson Reuters Lipper, 30.06.2018
³ Source: Investment Association, Investment costs and performance, August 2016