Be it a pension or an ISA, how do you know if the fund you’re paying into is a good investment?
The answer is by reading the fund fact sheet – each fund that you want to invest into has one.
However, with confusing terminology and acronyms, how do you know what to look out for?
First is if it is a Passive or Active fund – Active funds charge higher fees and perform worse.
Second is what fees they charge (fund and platform) – stay away from anything above 1%.
Third is the companies they’re invested in – are they globally diversified all cap companies?
Lastly is the benchmark they’re using – are they using a high or low performing benchmark?
In this post, I talk about how to know if it’s a passive/active fund and how to calculate its fees.
I also talk about the importance of the companies it invests in and what benchmark they use.
Finally, I share some examples of a good and bad fact sheet and where to find out more info.
Is it Active or Passive?
The first thing to note in a fund fact sheet is whether it is a passive or actively managed fund.
Active funds mean that they are managed by fund managers who try to beat the benchmark.
Passive funds are not managed by fund managers because they try to match the benchmark.
As a result passive funds tend to not have high fees as there is very little admin work involved.
Active funds tend to charge high fees because they are managed by a team of fund managers.
So the question is – how do you know if a fund is active or passive? Is it easy to identify them?
Basically, if on the fund fact sheet, it mentions a fund manager(s), then it is an active fund.
What this means is that the fund is going to charge high fees and its performance will be ok.
As for passive funds, they won’t have fund managers on the fact sheet or will just say ‘passive’.
Passive funds are the way – they charge significantly low fees and have a great performance.
What are the Fees?
The second thing to look out for in a fact sheet are its fees: what fees does this fund charge?
Note that there a few additional fees, but we’ll just focus on the fees that the fund charges.
In an active fund, fees will always be higher – you are paying someone to manage your fund.
In a passive fund, the fees will be lower – you are not paying anyone to manage the fund.
Therefore, in order to choose the lowest fees (yet best performance), choose a passive fund.
So you’ve chosen a passive fund – great, but how do you know if the fees are good or high?
For example, say you come across a fund that’s 1% in fees – 1% fees sounds pretty good right?
Wrong – 1% in fees is very bad; too much to be paying for a fund, especially a passive fund.
For example, a typical fee for an index fund is 0.04 – 0.23%; now that’s a good fee to have.
As a guide: 0.5% or less is great; between 0.5–1% is ok; 1% or more-get the heck out of there.
What Companies are they Invested In?
The next thing to examine in a fund fact sheet are the companies that the fund is invested in.
There are a couple of things to look it when it comes to analysing the companies in any fund.
Firstly, how many companies is the fund invested in: the more companies there is, the better.
Even 100 companies isn’t enough, there needs to be at least a few thousand to minimise risk.
Secondly, where are these companies located – are they located in one country or worldwide?
You want your fund to be globally diversified, not in just invested in one country or economy.
Thirdly, what size companies are they invested in – start-ups or the biggest global companies.
You want the fund to be heavily invested in the large companies and less in the smaller ones.
There are other things to consider also such what industries they are in, their weighting, etc.
A rule of thumb: if you don’t recognise the top 10 companies invested in the fund, run away.
What Benchmark is it Tracking?
The other thing to analyse in any fund fact sheet is the benchmark associated with that fund.
A benchmark is a tool that financial bodies can create to measure the performance of a fund.
If a fund is performing better than a benchmark – great. If it’s performing worse – not good.
How do you know what benchmark the fund’s tracking? It’s usually in the title of the fund.
E.g. Vanguard Global All Cap fund is a Vanguard fund tracking the Global All Cap benchmark.
So then as long as the fund is matching or outperforming the benchmark then all good right?
Wrong – you need to pay close attention to what benchmark the fund is being compared to.
Some passive funds like to compare with low performing benchmarks that are easy to beat.
For the untrained investor, you would then think that this passive fund must be incredible.
As a guide: choose a fund that matches the performance and companies of the benchmark.
Good vs Bad Funds
At this point, you’re probably wondering – so what is an example of a good and a bad fund?
Take Vanguard FTSE Global All Cap Index Fund; this is an example of a good fund to invest in.
It’s a passive fund, 0.23% fees, globally diversified companies, tracking the FTSE Global index.
What about a not so good investment fund – Scottish Widows International Equity Tracker.
An active fund, 0.63% fees, companies I don’t recognise and underperforming the benchmark.
With this info, take a look at your pensions/investments – are they invested in a good fund?
To find out more on index funds, check out the book The Simple Path to Wealth by JL Collins.
the author talks about how he considers equity index funds the greatest wealth building tool.
Are you investing in index funds? Which ones are you invested in? Share in the comments.
If you have any future blog article suggestions, please let me know in the comments below!
