CHOOSING INVESTMENT FUNDS – THINGS TO THINK ABOUT

We no longer use investment approach definitions to classify our funds. 

When it comes to investing, you need to ask yourself how much risk you're prepared to accept for the potential of a return on your money.

Your money is placed in investment funds, which are a way of pooling money together with other investors. Each fund invests in ‘assets’ and is professionally managed by a fund manager. 

The fund manager’s job is to run the fund in line with the stated investment objectives, aiming to meet declared targets. There are two main types of investment fund – passive and active. Both types aim to make money from whatever assets they hold – usually shares, bonds,  cash or property. Different investment funds have different levels of risk and aim for different levels of growth. 

Passive funds

Passive or ‘tracker’ funds aim to deliver a performance that’s in line with the market – they don’t aim to beat it, but simply replicate the movement of the market they’re tracking.

One of the most commonly tracked things is the FTSE All-Share Index, which is an index of around 600 of more than 2000 companies traded on the London Stock Exchange. The fund will buy shares in each of those companies and in the same proportions as their market value. The value of the fund moves in line with the change in the value of the FTSE All-Share Index.

Because managers of passive funds don’t have to pick which investments to hold in their funds, the performance of the fund depends entirely on the performance of the index being tracked. So if the market falls, so will the value of the fund.

Passive funds are often cheaper than active funds. They don’t have a management team making investment decisions, and may trade less frequently. These processes are often automated.

Active funds

These work differently. The job of an active fund manager is to pick specific investments, with the aim of delivering a performance that beats the fund’s stated benchmark (or standard). This could be an index such as the FTSE All-Share mentioned above. Together with a team of research analysts, the manager will actively buy, hold and sell investments to try to do this.

An active fund manager may be able to react to any market tumble by pulling out of troubled sectors and investing in other things, but if they get it wrong, they might lose.

Investment charges are often higher to cover the cost of the expertise of the fund manager and research analysts, as well as additional costs due to more frequent trading of the investments that the fund holds.

Asset types

There are four main asset classes. Each one works in a different way and carries its own particular investment risks. Fund managers buy and sell these assets on your behalf, with the aim of increasing their value over a period of time.

Many investment funds are diversified. This means they spread your money out across lots of different assets to reduce the chance that the value will go down. If one asset falls in value, other ones may rise so that the overall risk is lower.

But remember that the value of your investment is not guaranteed and can go down as well as up. You may not get back the original amount you invested.

Take a look at each asset class to find out more about their potential for 'risk and return'.

Money market funds invest in cash deposits, for example in a bank or building society account, or short term (normally less than one year) loans to raise cash. They don’t operate like a savings account.

Investing in these types of assets is lower risk in terms of losing any money compared to bonds and shares. This is because cash investments don’t tend to rise or fall in value very much. But cash does come with its own risk. Because cash funds don’t tend to go up in value all that much, your money might not keep up with the rising cost of everyday living over time (known as inflation).

These are loans to companies or governments which provide an agreed rate of interest until a set date. Funds holding these types of assets tend to produce lower but more stable returns than shares. They can be used as part of a portfolio to balance out higher risk investments.

Bonds can give a more predictable return but have less scope for growth than shares. Investing large amounts in bonds can mean your money doesn’t grow as much as if it were invested in shares, and may not keep up with inflation.

Bonds are usually seen to be less risky than shares. But they can still rise and fall in value.

Most people will want to have some shares, and some bonds. This is so they might benefit from the greater potential growth of shares, while also reducing the risk by having bonds.

Property funds invest in commercial property and aim to deliver rental income as well as capital growth. Depending on the market conditions, their value can fall quite sharply. They are therefore more suitable for longer term (more than 10 years) investing, giving them more time to recover.

Property can take longer to buy or sell than other assets -from time to time this may impact property funds, resulting in delays switching between funds, taking benefits, surrendering  or transferring. For example, the COVID 19 pandemic resulted in the suspension of a number of property funds with investors unable to transact for a period of time.

As a stake in companies, growth depends on several factors including how well those companies perform. Over time, they are likely to offer greater potential for higher returns, but with it greater changes in value. This is because they are volatile (their value can rise and fall quickly). While they carry the greatest risk, they may provide the greatest return over the long term (10 years or more).

Shares are also known as stocks or equities. When you buy a share, you’re buying a small part of a company. The risk with shares is not knowing whether the share price of the company will rise or fall.

The share price tends to rise if the company is doing well. But, if the company isn’t doing so well, the share price could fall.

In the short term, the value of shares can go up and down quite unpredictably. (This is called ‘volatility’.) So while they have a higher chance than bonds of good growth, they also hold a higher chance of bigger losses.

Generally though, in the long term (at least 10 years), the value of shares tends to go up over time and give longer-term growth.

Risk, return and volatility

At its simplest, volatility is a way of describing how much the value of something goes up and down. In volatile periods, values go up and down sharply, while in less volatile periods their performance is smoother and more predictable.

A more volatile investment will tend to see frequent and/or sharp rises and falls while a less volatile fund is likely to both go up and down more slowly.

Risk, on the other hand, is the chance of investments declining in value.

Higher risk investments are likely to go up and down more in value over time.

Choosing a low risk investment means that the value of your investment is likely to go up and down by smaller degrees but you are less likely to see higher growth. Such an investment will normally change less in value over a period of time. In real terms, it may not keep up with the cost of buying things over time.

When investing, the general rule is that the greater the potential for growth, the more risks you may need to take.

You have to accept some level of risk when you make an investment but how much depends on what you want to achieve, how quickly you hope your money will grow, and how much it would affect you to lose some or all of your investment.

Only you know what your goals are and how much risk you’re prepared to accept to reach them.

Depending on the funds you choose, the levels of risk and potential investment performance differ. The value of your investment and any income from it is not guaranteed and can go down as well as up. You may not get back the original amount invested.

For further fund information, see our funds guides which give more information about each fund’s aims and risks.

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