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How to pick a good fund for your ISA and pension
There are thousands of investment funds. Here are some tips on how you can find the best ones.
by Gavin Lumsden on Dec 14, 2012 at 13:09
The Christmas and New Year holidays can be a good time to review your finances. Here are some pointers on how to pick good funds from the thousands available if you are thinking of starting an ISA or pension or checking the progress of investments you've already made.
This is the latest video in The Lolly Investor Programme series, my weekly investment guide for beginners. In this video I refer to earlier videos I made explaining the different types of investment funds you can hold within an ISA or pension.
If you want to see them they are:
1) What are investment funds and how do they work?
2) What is a unit trust and how does it help me invest?
3) The Lolly guide to investment trusts: a 'hidden jewel' no more.
4) What are exchange traded funds (ETFs) and are they for me?
Welcome to The Lolly Investor Programme,
Christmas is almost upon us. People are rushing around looking for presents to buy friends and family. Once the shopping frenzy is over many people will use the holiday to review their finances and check on their savings.
So with an eye to those New Year resolutions, it’s time to ask, what should you look for in an investment fund? How do you pick a good fund for your ISA and pension?
First, let’s recap on the basics. What is a fund?
A fund pools the money of many investors and allows each individual to invest in a much wider range of investments than they could do on their own.
There are three main types of fund: unit trusts or open-ended investment companies; investment trusts; and exchange traded funds.
If you want to know more about these do watch the three videos I made on them earlier in the series.
My following tips apply to all fund types.
The first step is to narrow down the field.
There are thousands of investment funds which does make choosing one tricky.
Fortunately, investment funds are divided into sectors. These reflect the asset class and the region they’re investing in.
There are a number of investment websites that list all the fund sectors. One of them is Citywire, the publisher of The Lolly.
As you can see there’s a range of sectors of funds investing in shares, or equities, both in the UK and abroad.
There is a similar list for bonds and property.
And there are also funds that invest in a mix of these asset classes called mixed asset funds.
Fund sectors are like league tables. They help you compare the performance of funds that are doing a similar job.
For example, if you want to invest in the shares of UK companies, a big sector to look at is UK All Companies. Funds in this sector invest in the shares of companies listed on the London Stock Exchange, the UK’s stock market.
There is also a UK Smaller Companies sector for funds investing in the shares of smaller companies. These funds are higher risk but can deliver higher returns.
There is also a ‘UK Equity Income’ sector for funds aiming to generate an income for investors from the dividends paid by UK companies.
You get similar sectors or league tables for funds investing in Europe, Asia, the US and globally.
Once you’ve chosen a sector you need to think about whether you want an actively managed fund or a passively run fund.
An active fund will be run by a named individual fund manager. He or she will try to pick the best investments in their area in order to maximise the return to their investors.
A passive or tracker fund will not have a specific manager in charge. It will simply aim to track a stock market index such as the FTSE All Share.
In the hands of a good manager an active fund may well beat an index tracking fund, but it will charge more.
It’s not always possible to tell which funds are active and which are passive when looking at a fund sector so keep this choice at the back of your mind as you continue your research.
The next step is to look at the sector you’ve chosen in more detail and pick out the funds producing the best returns.
We’ve all seen the small print in investment adverts that says past performance is no guide to the future.
That’s not totally true. In fact there is evidence that funds that achieve the top quarter of a sector over a three- or five-year period stand a better chance of staying at the top of their league table in future.
Besides, past performance is all you’ve got to go on when choosing a fund.
The great thing about sector tables like this is that you can compare how much money different funds have made over different periods.
Find out if there are any funds producing above average returns over one year, three years, five years and even 10 years, if the funds have been going that long.
Some websites like Citywire have tools that enable you to analyse the performance of funds in terms of the risk they are taking.
Professional investors don’t just look for funds that are at the top of their sectors but those that deliver the best risk-adjusted return.
The ideal fund is one that will generate a good return with less risk than its rivals. One way of measuring risk-adjusted returns is the Sharpe ratio. A fund with a higher Sharpe ratio is delivering more bang for your buck as it were.
However, you can’t avoid all risk so always invest with at least a five-year view in mind.
Once you’ve got a short list of funds, the last step is to find out more about them.
All investment companies have fact sheets on their funds, detailing where they’re investing and the fund manager’s latest thoughts on the market.
Fact sheets are a good source of finding out how funds have performed in different years.
If you find a fund that falls less than than the stock market in bad years and rises faster than its benchmark index when markets are rising, you may be on to a winner!
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More from us
- The Lolly Investor Programme: a video guide to investing
- What are investment funds and how do they work?
- What is a unit trust and how does it help me invest?
- The Lolly guide to investment trusts: a 'hidden jewel' no more!
- What are exchange traded funds (ETFs) and are they for me?