You may not feel like you need assistance with asset-picking but there are other areas in which funds provide value to an investment portfolio, regardless of whether you are a first-timer, or professional investor.
Expertise on tap
Chances are, you have a full-time job. You probably also have responsibilities and commitments that require varying amounts of your free time. Managing an investment portfolio can be complicated, if not in the very least time-consuming and you may feel apprehensive about the commitment involved in actively managing investments.
Having your money managed by a fund manager removes this problem. He or she is a professional investor with the depth of experience and resources necessary to meet the objectives of the fund. Using funds allows you to be as hands-off or hands-on as you’d like, utilising the industry’s professionals to work in their area of expertise on a full-time basis, as you do yours elsewhere.
Let’s imagine that you invest in stocks. If one of the 10 stocks in your portfolio falls substantially you will be left with noticeable damage. If one of those companies goes bankrupt then you’re left to reconcile a 10% loss of your money. If your portfolio of 10 stocks is actually only a portfolio of 5 stocks then you’re looking at a 20% loss….if you only hold 2 stocks, then the damage becomes critical…
Conversely you could diversify by purchasing 50 stocks. In this scenario you must consider the transaction cost and brokerage commissions effect on the returns of the portfolio and calculate what it’s costing you to even participate.
Many investors have dangerously over-concentrated portfolios. You probably know somebody who only has investments in one country, or one currency, or even in just one company (you might even have company stock options yourself?). Funds are able to mitigate this risk by diversifying across numerous asset classes in a cost-efficient manner without being subjected to excess costs or over-exposure to one underlying asset.
Buying into a collective investment like a fund enables you to participate in the growth of numerous underlying assets, handpicked by a team of professionals. You may feel comfortable with hand-picking UK equity, or perhaps US fixed-interest securities, but would feel more comfortable having the assistance of the professionals in Brazil when taking positions in Brazilian securities, or leaving the decisions to the teams based in Hong Kong when looking to invest in Hong Kong. Funds allow you to hand-pick professionals in potentially hard-to-access markets, and then benefit from their regional expertise.
Percentage of Households holding Mutual Funds
Access To Markets
Benefiting from the economics of scale you will often be able to access opportunities not open to retail investors due to the high capital entry requirements (i.e high minimum investments or high net worth requirements). Most investors will not have enough money to be able to, for example, build a diversified property portfolio. Collective investments can be a cost effective way to diversify your money outside of equities.
One of the disadvantages of collective investments would be the dilution effect. Even if the fund holds the stock of a stellar company whose share prices doubles, it will not produce a huge difference in the returns of the fund due to the diversified nature of the fund having managed exposure to each underlying asset.
That being said, you could select funds based upon their objectives and condense your exposure that way, i.e have 40 % in US equity, 30% in European equity, 10% in UK equity and 20% in fixed interest securities to make sure that you do not miss out on exposure to larger trends, without having to make binary yes/no decisions about potentially hundreds of individual securities. You might even want to take a look outside of the Fund universe and look to ETF’s for higher beta investments to fulfil a larger risk appetite [we will be taking a look a thematic look at ETFs in our next quarters Insights update…]
As with most investments, you may find yourself liable to pay tax when you sell funds or have tax deducted from any dividends/distributions paid to you, depending on your tax position and the tax status of the fund.
If that applies to you, then you should consider how best to plan your taxes and reporting so as to minimize your liabilities and remain compliant with the tax framework of your home, or resident country. Do you have allowances? Can you take advantage of gifting? Does capital gains tax (CGT) exist or do investment returns constitute income? There are a number of areas for you to optimise your situation and money saved through prudent planning is just as important as the money earned through prudent investing.
All investments can fall in value as well as rise; you might lose money. Tax rules can change. In particular, any favorable tax treatment will depend on your individual circumstances. Managing your own investment portfolio is not for everyone; you must have the necessary skills and if unsure you should seek independent advice.
US Retirement Plan Fund Asset Allocation and Participant Age
Average asset allocation of 401(k) account balances, percentage of assets, year-end 2011