There are many different types of investment strategies and tools available to investors today as shared in our previous article. Some people might favour purchasing individual stocks themselves, while others may favour to buy the best funds that are professionally managed.
There is no right or wrong approach; rather, it depends on each person’s level of risk tolerance. Also, if one chooses to buy in stocks on their own, they will need to devote time in understanding the businesses.
Investing in funds may be an appealing alternative for investors who prefer a more passive strategy. However, there are numerous funds, including mutual funds, index funds, and more for investors to choose from. Hence, we aim to educate our readers on things to watch out for before deciding to invest in one. This will also serve as a guide to evaluate and buy the best funds that suits you the best.
5 Key Factors to Buy the Best Funds
1st Buy the Best Funds Factor: Expense Ratio
Expense Ratio is termed as the total fees being charged to investors for those who purchase these fees. These fees cover both Ongoing expenses and Sales loads. Ongoing expenses cover portfolio management, distribution charges and more that are charged annually. On some occasions, there are also “Sales loads” which typically charge from 0% to 5% of the total investment. This is a one-off charge that can be paid at the time of shares purchase or shares redeemed.
There was a MorningStar study, to discover the different expense ratio for mutual funds and index funds for 2021. For Mutual and Index Funds, their average expense ratios were 0.68% and 0.06%, respectively. Index Funds typically have lower expense ratios as they are passively managed. On the other hand, Mutual Funds are actively managed which involves investment professionals making active decisions to buy and sell.
Some people could believe that the 0.6% difference is negligible in terms of return. This is far from the truth. Let’s take a step back and consider it for a longer time horizon for investments.
Let’s use the example of a $10,000 initial investment to demonstrate this. Suppose that after expenses, Index Funds and Mutual Funds have annual returns of 7% and 6.38%, respectively. Over 10, 20 and 30 years, the return difference stands at 4.68%, 13.20% and 22.76% in favor of Index funds. Hence, to optimize returns over a long period of time, do search for funds with lower expense ratios.
2nd Buy the Best Funds Factor: Fund Performance
Fund Performance is a key factor to consider when evaluating as it provides insights into the fund’s historical returns. Furthermore, this will also demonstrate the fund’s potential for future growth.
To accurately evaluate a fund’s performance, it is essential to analyze its performance over multiple time frames and relevant benchmarks. Short-term observations can be misleading and may not accurately reflect a fund’s true performance. For example, due to the stock market’s upward trend between 2015 and 2020, most funds performed well during this period. Therefore, we will strongly recommend assessing a fund’s performance over a minimum of 10 years.
Moreover, if one were to consider purchasing mutual funds, we will advise to use NASDAQ or S&P 500 as a reliable benchmark for comparison. Numerous index funds track the above benchmarks and offer a low expense ratio. For instance, the S&P 500 has grown by over 57% over the 5 years despite the recent correction. Consequently, a mutual fund must consistently outperform these benchmarks to justify its higher expense ratio and appeal to potential investors. Thus, we will advise everyone to assess funds’ performance over 10 years and benchmark with S&P 500.
3rd Buy the Best Funds Factor: Diversification
Diversification is an essential factor to consider when evaluating index and mutual funds. Both index and mutual funds provide investors with instant diversification across a broad range of securities.
Typically, index funds track a specific market index, which holds a diversified portfolio of securities that represent the underlying index. While mutual funds typically hold a diverse mix of securities, such as stocks, bonds, and other asset classes. They are managed by the fund manager to align with the fund’s investment objectives.
Example: Fund Fact Sheet or Prospectus Document
The top holdings for each fund are listed in the prospectus document so that investors can understand the underlying equities. Also, investors will be able to assess whether the underlying securities match their risk tolerance. Hence, investing in a well-diversified fund can significantly reduce one portfolio’s impact on market fluctuations. Furthermore, one can also take advantage of opportunities across different asset classes and sectors.
4th Key Fund Evaluation Factor: Reputation of Fund Manager
The fund managers are responsible for overseeing the fund’s operations and implementing its investment strategy. The fund manager’s expertise and experience plays a significant impact on the fund’s performance. As a result, it is essential to assess the manager’s qualifications and track record.
The manager’s experience and track record are also important indicators of their ability to manage the fund effectively. It is essential to evaluate the manager’s performance over various bulls and bears market cycles. This will allow us to evaluate their ability to manage risk and generate consistent returns. Some notable Fund Managers that have performed consistently well includes: Vanguard, BlackRock, Fidelity and more. Hence, it’s crucial to pick a fund that is competently managed by a renowned fund manager.
5th Key Fund Evaluation Factor: Withholding Tax Consideration
Withholding tax is an important factor to consider when evaluating index and mutual funds. This is a tax levied by foreign governments on income earned by non-residents. This is particularly for investors who hold funds that invest in foreign stocks or bonds. For Singaporean investors that often invest in US, China or Foreign funds, we will be subjected to this tax.
For US and Chinese funds, the withholding tax is currently 30% and 10%, respectively. Investors should take particular attention if they are investing in a dividend fund because it will affect their returns. Hence, investing in a foreign growth fund might be more appealing because these funds often don’t distribute dividends.
Evaluating and selecting the right index funds, ETFs and other funds is an important part of any investor’s financial strategy. With the 5 key evaluation factors we shared, you can quickly identify and buy the best funds that best fits you. Do take some time to research the fees, past performance and underlying securities before coming into a decision. Ultimately, never rush into a decision as we typically invest in a fund for a long duration. We sincerely hope that this post will be helpful to you in your search for the best investment fund opportunities.
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If you are keen, check out our articles on other analysis: Trust Bank Referral, Diversification Strategies for a well-rounded portfolio and 8 Things I learnt from the DBS 2023 AGM.
Disclaimer: The information provided by LearnToInvest serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.