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What is more important to you – growing your wealth, or preserving it? If it is the latter, then any investment that reduces volatility (large, short-term price fluctuations) will be appealing. These may include cash and UK government bonds. However, if you want to grow wealth over many years, then this means considering “higher risk” investments which offer higher potential rates of return. Mutual funds often fall into this latter category.
For the very cautious investor, this type of investing will likely be seen as “unsafe” due to the risk involved. Yet how risky are mutual funds, really? In this article, our team at Hanson Financial Services (financial advice in Liverpool) explores that question in more detail. We hope you find this content useful and invite you to get in touch if you’d like to discuss your own mortgage or financial plan with us.
What are mutual funds?
When you log into an investment platform, you may see lots of stocks (shares of companies) that you could buy. Another option is to invest in a stock which, as its primary business, uses investors’ money to invest in other businesses. This is called an ETF (exchange-traded fund) and can be bought/sold just like other stocks, and is usually “passively managed”. However, there are other categories of mutual funds – e.g. those run by professional fund managers who pick assets on investors’ behalf. It is this latter type that we are mostly concerned with here.
Why do some fear mutual funds?
Mutual funds can have a bad reputation for being fraudulent or unable to beat benchmarks. The case of Neil Woodford springs to mind, whose Woodford Equity Income fund started receiving scrutiny in 2019. After years of underperformance and investor withdrawals, the fund eventually was suspended and Neil Woodford resigned. The business had £16bn in assets in 2017, which had fallen to £3.1bn in the aforementioned fund by October 2019.
The fact that Woodford’s fund had been partnered with leading UK wealth managers – e.g. St James’s Place and Hargreaves Lansdown – shows that dangerous funds can even slip under the noses of very experienced, professional investors. However, it is worth noting that mutual funds are usually safer than trying to pick individual stocks yourself. This is because they contain a range of assets – rather than investing significantly in one company. If one asset falls in value, therefore, the others can help keep the overall fund performance up.
Assessing risk with mutual funds
Mutual funds come in many forms and involve varying degrees of market risk. Some focus on a particular sector (e.g. the ARKK Innovation ETF, which invests in “disruptive” tech companies), whilst others may concentrate on business size/type, such as UK small cap “growth” stocks. A more “cautious” mutual fund, however, may prioritise investment stability and “risk parity” during bear markets, such as Ray Dallio’s All Weather Portfolio. As such, choosing mutual funds partly involves aligning your options with your investment interests and values.
The other important factor in determining your fund choices is your risk tolerance. Some mutual funds may involve greater risk and volatility than others. Alongside this, you should also think about the underlying fundamentals of each fund. One of the problems with the Woodford Equity Income fund was that it contained a lot of large, illiquid assets. When investors wanted to take out their money, these assets comprised a higher percentage of the fund as “liquid” assets sold first. Eventually, asset sales could not keep up with withdrawal requests, causing a suspension. These are difficult risks to assess on your own, so taking financial advice can be very useful.
Pros & cons of mutual funds
Mutual funds are not completely safe. The value of your investment is not guaranteed. Markets may go up and down, and you may not get back what you originally invested. However, higher returns are on offer – e.g. compared to cash and bonds – with the right strategy. Mutual funds can also present some attractive benefits to investors. They offer simplicity, since you need not pick stocks yourself. Rather, you bestow this responsibility to a fund manager, allowing you to get on with life. Mutual funds can also offer diversification and advanced portfolio management – something which could, in rare cases, allow you to “beat the market”.
With this said, make sure you discuss the risks of your mutual fund choices with your financial adviser. In particular, mutual funds can come with costly fees that can eat into your returns. They are likely to not beat the market on a consistent basis (which leads many investors to consider lower-cost index funds instead). Mutual funds also take away investment control, as you have no say over the manager’s buy/sell choices and may not even know the full extent of the fund’s holdings at a given time.
Conclusion & invitation
Are you interested in talking to a financial adviser about your financial planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]