Before you start, determine your investment goals

To determine your investment goals, start by identifying what you want to achieve – whether it’s buying a home, saving for education, travelling, or preparing for retirement. Being clear on your goals helps you stay motivated and decide on your risk tolerance.

Next, consider your time frame. The longer you have, the more risk you can take, as you have time to recover from losses. For long-term goals like retirement, higher-risk investments may be suitable, but for short-term needs, like home renovations, you’ll want to avoid volatility.

The risk factor

It’s a cliché, but a true one – if you’re lying awake in bed at night worrying about whether you’re losing money, you’ve taken on too much risk for your comfort levels.

Generally, the longer your time frame, the more risk you can afford to take, as you have time to recover from some periods of loss and hopefully still come out ahead. However, if it’s causing you to lose sleep – it’s not worth it. It’s a good idea to decide at the outset how much risk you want to take so you don’t find yourself in over your head down the track.

Remember, not all equity funds are the same. A biotech or technology fund is likely to be much more volatile than a fund which invests in high-quality defensive companies.

Considering past performance

How a fund has performed in the past is the most obvious place to start when picking a fund. However, you shouldn’t expect stellar returns just by picking the best past performing funds. Some funds get lucky, some take excessive risk, some lose their managers, some lose key support staff or become too big to manage effectively.

Additionally, the market is constantly evolving. Last year’s best-performing funds may not continue to deliver the same results in the following year, especially if different types of assets become more popular, or new trends emerge.

It’s important to consider a fund’s long-term consistency and the strategies behind its performance, rather than simply chasing past success or the next ‘star manager’.

Choosing the right manager

When looking for a manager, choose one with a proven track record who has experienced all market conditions. The manager should be settled and unlikely to move in the near future. Make sure the manager is not managing too many other funds, particularly if they have very different mandates. For example, avoid a manager who runs both a Japanese and a UK fund. There is no reason he or she should be doing this. Does the manager and their team speak the language/s of the areas in which they are investing in? Are they based in or near to that region?

Always consider how well aligned a manager is with their investors. Do they own the fund themselves? Finding managers who consistently outperform is not easy, but hundreds of managers have proven it can be done.

Understand the fund’s mandate

It’s important that you choose a fund that is right for you and your own circumstances. Never invest in something you don’t fully understand. Take time to do your own research and make sure you know exactly what the fund is investing in and how it delivers returns to its investors. Consider the past volatility and current yield for each fund. If you want income to fund your retirement, you may want high income payers, but remember this can come at the cost of lower capital returns.

You also want to carefully consider how much volatility you can take personally. What would you do if your investment fell 30%? Remember there will always be some sort of crisis; Ukraine, Europe, China or the financial crisis. If you’re investing for a long period, most equity markets will almost certainly suffer a major loss at some point. How would you react? Would you sell? If you couldn’t stand the loss, or it would keep you awake at night, you should probably consider investing in something less risky.

You also want to understand when you would expect your fund to do well and when you would expect it to do poorly. For example, when the market is soaring you would expect your growth funds to outperform. Your defensive funds might underperform, but that doesn’t necessarily mean they are bad funds. The fund may actually be fine and it might subsequently claw back any underperformance when markets fall.

Size

The size of a fund is also important to consider. A small fund may lack the clout to get access to companies’ management. A fund provider may also dedicate fewer resources to it, instead assigning their strongest analysts to larger and more important funds. A small fund will typically have higher expenses.

However, a fund which is too large may also have problems. Firstly, it may be limited to only investing in larger companies. This is fine if the fund is expected to invest in large-cap companies, but it can be a problem for funds which like to invest in small-caps. If you own a small-cap fund, keep a watchful eye on how large it gets.

A larger fund also has an inherent competitive disadvantage to smaller funds. When a larger fund buys or sells shares, it has a much bigger effect on the price of the underlying security. This ultimately means that unless a fund is very carefully managed, a larger fund can often get a worse price when it buys or sells. They are also a lot less flexible. It is usually difficult for a large fund to exit from a big position quickly or to shift with the economic cycle.

Other things to remember

Consider if your fund manager has the necessary resources to manage the fund effectively. Smaller fund providers may not be as effective at managing global funds or funds in faraway places which require a large number of bodies on the ground to be effective.

Also consider the turnover of the fund, or how much it trades. The more trades a fund makes the more costs that you, the investor, incur, although there are some funds which trade a lot and do very well.

Always be aware of the structure of your fund. Is it based offshore? Find out if the fund is covered in cases of fraud.

Don’t forget costs. The cost of a fund can impact on its total returns so it’s an important consideration. However, never choose a fund purely because it has the lowest charges. Returns after costs are arguably much more important. It’s better to pay a little more for a fund that should perform better over the long term, rather than pay less for a fund that underperforms.

Resources available at Chelsea

There will be hundreds of possible funds covering the areas to which you want exposure, so take your time to research them.

Examine their stated aims and objectives to gauge whether this meets your own objectives. Are you happy with the risks being taken? Do you agree with their overall outlook on the market?

The research provided on Chelsea’s research hub can be a good starting point, and less overwhelming than staring down a list of over 3,000 possible funds.

The Chelsea Selection is our wider list of around 100 top-rated funds, while the Core Selection offers a more concentrated version of roughly 40 funds. We research all these funds and meet and interview the fund managers, before they gain a place on either table. All these funds are available at 0% initial charge via one of Chelsea’s platforms.

Lastly, stay up-to-date

It’s important for investors to keep a watch on their funds. Managers can change and what a fund invests in can change greatly, especially when investing for a long period. Always try to review your funds periodically and consider re-weighting them if any one fund becomes too big a part of your portfolio.

Don’t be afraid to make changes to your ISA portfolio if it no longer meets your needs.

And, just because an investment fund hasn’t performed as expected, doesn’t always mean it should be axed. You first need to find out exactly what’s happened. There may be global or sector issues. Has a fund beaten or lagged its peer group? Is it invested in an area of the stock market that’s been out of favour but is likely to recover? Likewise, if a fund has done very well, it may account for a larger part of your portfolio than you are comfortable with and trimming your holding may be a good idea.