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Appointing someone as your guide in the financial jungle can be a daunting task. How do you assess whether they are any good? What pro-active steps can you take to make sure the person who you are dealing with has the knowledge and experience you want?
Whenever you meet with a financial planner you can expect to be told that you should diversify your investments to reduce risk. But how much diversification should you accept and when does it cease to become a good thing?
First, and from the outset, I am a fan of diversification. It does help reduce risk in all sorts of ways. Whether it is diversification of assets across cash, bonds, property and equities, or across fund managers, investment strategies or currencies – risk is reduced. However, to play devil’s advocate, reduced risk also means reduced potential returns and reduced potential for beating the market.
No one fund will provide you with complete diversification as you will still be subject to the preferences and bias of a fund manager or the company employing the fund manager. The way to reduce this ‘manager’ or ‘house’ risk is to invest in more than one fund. Even funds with the same investment objective can have very different results but you do have to be careful…
If two or more funds are investing in the same areas such as the FTSE-100 or S&P 500 they might often have similar holdings. So by investing in different funds you may not be diversifying your investments by as much as you think and where these funds just track the index returns very similar.
Some funds invest in other funds. These are known as fund of funds. These are super-diversifiers investing in 20 or more underlying funds which are usually accessed on favourable terms. If you have a relatively small amount to invest and you are concerned about diversification, a fund of funds approach may be the answer.
These funds are generally offered in various currencies and are managed within pre-defined risk parameters. Whilst the annual management charges are generally more expensive than buying an individual fund; professional portfolio management, fund research and reduced risk are advantages not provided by individual funds.
So how much diversification is enough? The answer to this question will depend on your thoughts on risk; the amount being invested and what your investment objectives are. An investment professional should discuss these important points with you to ensure that he or she has a good understanding of your needs before making any recommendations.
I hope you found the above useful. If you have any questions please contact me.
Experienced Investor Fund (EIF), Specialist Investor Fund (SIF), Qualified Investor Fund (QIF) are three investment fund categories. There are different definitions for each category depending on the jurisdiction in which the fund has been established. The common denominators are: they are not suitable for retail investors; they have high initial minimum investment amounts (typically more than US$100,000); require a high level of investment expertise or wealth as a pre-requisite for investing.
There are many reasons why an investment company would wish to set up their fund under one of these regimes; for example, they may specifically target institutional or experienced investors; the investment strategy or asset may not be suited to retail investors. In return, regulation and establishment processes are generally less onerous.
As with any investment, an investor should only invest in something they understand. The best way to determine whether a fund is suitable for you is to read the legal documentation issued by the fund management group. This may be known as the fund prospectus, private placement memorandum (PPM) or fund particulars.
These are not marketing documents. They will not focus on performance. They are intended to set out the charges, investment strategy and potential risks of investing. They also contain additional information which may help you make an informed investment decision such as whether the fund falls into one of these three investment fund categories.
If you are worried about the time spent reading and understanding the prospectus, consider the amount of time it would take you to earn the money you are investing. This should help put the few hours you spend understanding your investments into perspective.
If the fund does fall into the EIF, SIF or QIF categories you should then satisfy yourself that you meet the eligibility criteria. If you do, you should then consider the investment proposal.
If you do not, then you should not proceed and should instead continue your search for a suitable investment no matter how attractive the investment looks. Selecting an investment is a process of matching your needs to suitable investment opportunities which reaches much further than just investment performance.