Don’t put all your eggs in one basket

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Investing in funds rather than individual stocks and shares may have advantages such as lower risk and less hassle.

If you have a full-time job or young children keeping you busy, you may find that picking stocks and bonds yourself can be too time consuming. There’s also a perception that DIY investing requires an intimate knowledge of capital markets, poring over companies’ annual reports and paying high trading fees, which can sound daunting and may put people off.

There is a simpler way to build a diversified portfolio and that’s by investing in funds. Funds can remove much of the hassle but they still allow you to keep a close eye on your investments.

Risk: Diversification and asset allocation may not fully protect you from market risk.

In the RSA, members of the Investment Association (ASISA) manage funds worth R3.5 trillion.1The economies of scale in this sector are very useful because pooling your money with other people can lower the cost of investing. They also give the fund manager the resources to create a more diversified portfolio of different asset classes, sectors and geographical regions, and a diversified portfolio reduces risk.

The beauty of having your eggs in different baskets is that while certain stocks or bonds might fall in value, others may not be affected and this also helps minimise risk. So your main decision is which type of fund or combination of funds is right for your goals and risk profile. The three main categories to choose from are active funds, index funds and investment trusts.

An active fund involves the fund manager buying and selling stocks and bonds on your behalf. The manager is simply aiming to beat returns from the broader market and deliver steady positive growth. The manager will conduct their due diligence with every holding and can even meet company heads before deciding whether to invest.

Index funds are usually either index-tracker unit trusts or exchange-traded funds. There may be differences in their structure but the purpose of all index funds is to track a given market, whether that’s the biggest global companies or the most liquid bonds. As the market moves up and down, so will your fund.

Investment trusts are another form of active fund that have been around since the 19th century. Investors buy and sell a fixed number of shares in much the same way as they trade shares in individual companies. The share price goes up and down depending on supply and demand and the fortunes of the company concerned.

However, the structure of the investment trust means that when there’s a lot of demand, its share price can climb higher than the value of the underlying securities that the fund invests in. So the trust is trading at a premium. If demand falls, the trust will trade at a discount. Much of the return investors make with investment trusts depends on whether the share price climbs to an even higher premium or rises from a discount back to net asset value.

Investment Trust Disclaimer: Net Asset Value (NAV) performance is not the same as share price performance, and shareholders may realise returns that are lower or higher than NAV performance.

Regardless of which fund you choose, some basic rules apply: whatever the investor makes in returns, there will always be fees to pay, so it’s important to shop around. Fees vary per fund and are expressed as an OCF (ongoing charge figure) in percentage terms. Index funds tend to be cheaper than actively managed funds because once the index fund has been set up to track a particular index, there isn’t much maintenance required. The manager of an active fund, on the other hand, is constantly evaluating which securities they should buy and sell. Similarly, an investment trust manager is always looking for the best securities. Both types of active fund will aim for low turnover because trading fees can eat into your returns.

You can check if your fund’s fees are competitive by comparing average costs. These differ depending on the asset class, geographical region and sector you’re investing in, as well as the fund type. In Europe, an index fund that invests in equities typically costs less than those that focus on stocks in more esoteric markets in Africa and Asia because these are less liquid and harder to access.

OCFs for actively managed funds investing in a mix of companies are often 0.5-1.5%, while index funds focusing on companies with strong environmental, social and governance (ESG) credentials attract a similar charge.2 Although past performance does not indicate future returns, it is always worth looking at the active manager’s track record to see if they have beaten their benchmarks over time.

It’s also worth remembering that no investor or fund manager can guarantee success. The more diversified the fund’s holdings and the lower the fee, the more chance you have of making a return. Lastly, all investment strategies should be geared for the long term and not seen as a way of getting rich quick. If you stick to your plan and keep your risks and costs low, you can usually sit back, relax and let the professionals manage your investments.

1Source: Association for Savings and Investment South Africa (ASISA), Media Release, 5 March 2024
2Source: Morningstar, 5 October 2023