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Learn how to evaluate managed funds and find the right one for you.
Are you thinking about investing in a managed fund, but aren't sure how to go about it or which one is the most appropriate based on your needs? You're not alone. However, what you may not know is that the selection process is much easier than you think.
Identifying Goals and Risk Tolerance
Before acquiring shares in any fund, an investor must first identify his or her goals and desires for the money being invested. Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for educational expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the thousands of managed funds in the public domain.
In addition, investors must also consider the issue of risk tolerance. Is the investor able to afford and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment warranted? Identifying risk tolerance is as important as identifying a goal. After all, what good is an investment if the investor has trouble sleeping at night?
Finally, the issue of time horizon must be addressed. Investors must think about how long they can afford to tie up their money, or if they anticipate any liquidity concerns in the near future. This is because managed funds have fees, that can take a big bite out of an investor's return over short periods of time. Ideally, managed fund holders should have an investment horizon with at least five years or more.
Style and Fund Type
If the investor intends to use the money in the fund for a longer term need and is willing to assume a fair amount of risk and volatility, then the style/objective he or she may be suited for is a long-term capital appreciation fund. These types of funds typically hold a high percentage of their assets in stocks, and are therefore considered to be volatile in nature. They also carry the potential for a large reward over time.
Conversely, if the investor is in need of current income, he or she should acquire shares in an income fund. Government and corporate debt are the two of the more common holdings in an income fund.
Of course, there are times when an investor has a longer term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds, may be the best alternative.
Charges and Fees
Managed funds make their money by charging fees to the investor. It is important to gain an understanding of the different types of fees that you may face when purchasing an investment.
Some funds charge a commission, which will either be charged upon initial investment or upon sale of the investment. An entry fee is paid out of the initial investment made by the investor while an exit fee is charged when an investor sells his or her investment.
Both types of funds typically charge around 2% or higher of the total amount invested or distributed. Its purpose is to discourage turnover and to cover any administrative charges associated with the investment. Depending on the managed fund, the fees may go to the financial adviser for selling the managed fund or to the fund itself, which may result in lower administration fees later on.
To avoid these fees, look for nil entry and exit fee funds. However, be aware of the other fees such as the management expense ratio and other administration fees, as they may be very high.
One final tip when perusing managed fund sales literature: The investor should look for the management expense ratio. In fact, that one number can help clear up any and all confusion as it relates to sales charges. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower the investor's return will be at the end of the year.
Evaluating Managers and Past Results
As with all investments, investors should research a fund's past results. To that end, the following is a list of questions that perspective investors should ask themselves when reviewing the historical record:
* Did the fund manager deliver results that were consistent with general market returns?
* Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
* Was there an unusually high turnover (which can result in larger tax liabilities for the investor)?
This information is important because it will give the investor insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return.
With that in mind, past performance is no guarantee of future results. For this reason, prior to buying into a fund, it makes sense to review the investment company's literature to look for information about anticipated trends in the market in the years ahead. In most cases, a candid fund manager will give the investor some sense of the prospects for the fund and/or its holdings in the year(s) ahead as well as discuss general industry trends which may be helpful.
Size of the Fund
Typically, the size of a fund does not hinder its ability to meet its investment objectives. However, there are times when a fund can get too big. A perfect example is the US fund, Fidelity's Magellan Fund. Back in 1999 the fund topped US$100 billion in assets, and for the first time, it was forced to change its investment process to accommodate the large daily (money) inflows. Instead of being nimble and buying small- and mid-cap stocks, it shifted its focus primarily toward larger capitalisation growth stocks. As a result, its performance suffered.
So how big is too big? There are no benchmarks that are set in stone, fund size certainly makes it difficult for a fund manager to acquire a position in a stock and dispose of it without running up the stock dramatically on the way up, and depressing it on the way down. It also makes the process of buying and selling stocks with any kind of anonymity almost impossible.
Selecting a managed fund may seem like a daunting task, but knowing your objectives and risk tolerance is half the battle. If you follow this bit of due diligence before selecting a fund, you will increase your chances of success.
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