How to Choose the Right Investment Fund

Are you thinking of investing your money in investment funds? This moneyland.ch guide tells you what to pay attention to.

Why should I invest in funds at all?

Investment funds make it easy to invest in a diversified array of different assets and asset classes, and are particularly interesting if you have relatively little capital and/or investment know-how. A stock fund, for example, may be made up of dozens or even hundreds of different stocks. You would, in many cases, have to invest thousands of francs in order to create the same portfolio by buying individual stocks yourself. But fund shares often cost much less than that, letting you invest in many different stocks even if you only have a smaller amount of money to invest.

If you have pillar 3a retirement savings which you want to invest instead of keeping them in a retirement savings account, the you will hardly have any alternative but to use investment funds. The reason is that, with most providers, you are not free to invest pillar 3a savings as you choose, but have to use retirement funds. You can find an interactive retirement fund comparison on moneyland.ch. Retirement asset management services let you invest your pillar 3a savings in a portfolio made up of many different investment funds and other investment vehicles.

Which kinds of funds are there?

There are various categories of investment funds which invest in different markets. These categories are common:

• Stock fund

Stock funds invest in stocks. Historically, this asset class has the highest chances of delivering returns on your investments. But the risk of losing money is also higher.

• Bond fund

Bond funds invest in bonds (corporate bonds or government bonds). These are investments which yield interest at fixed rates. The potential returns on your investment are lower than those of stocks, but the risk of losing money is also relatively low.

• Real estate fund

You can use real estate funds to invest in the real estate market, without having to buy property yourself. The fund buys and manages real estate, and distributes possible profits to its investors.

• Money market fund

Money market funds invest in liquid money market instruments (certificates of deposit, for example). This kind of fund is suitable for temporarily investing financial reserves in order to earn returns with little investment risk – while you decide on how to invest over a longer term, for example.

• Strategy fund

Strategy funds invest in several asset classes, instead of just one. For example, a strategy fund may invest 50 percent of its capital in stocks, and 50 percent in bonds, enabling you to invest in both stocks and bonds by buying shares in just one fund. But note that strategy funds tend to be expensive. In some cases, using different funds to invest in different asset classes can work out cheaper than using a strategy fund.

Which kind of fund is ideal for you depends on your specific investment goals. If you want to invest in stocks over long terms, then a stock fund is a suitable choice. If you prefer less risk with lower potential returns, then a bond fund could work for you. In many cases, it makes sense to invest in more than one asset class – by buying shares in several different funds, for example.

Investment themes can also play a role within specific asset classes. For example, you may want to invest in a specific technological sector, or in a specific country, or in sustainable companies. There are numerous specialized thematic funds which invest based on a specific theme.

Which is better: actively-managed or passively-managed funds?

Investment funds may be actively-managed or passively-managed. An actively-managed fund has asset managers who decide on the fund’s investments on an ongoing basis. A passively-managed fund follows a fixed investment plan and does not need active administration.

Typically, actively-managed funds are much more expensive than passively-managed funds. But even with their higher running expenses, they have not been proven to perform better than passively-managed funds over long terms. Because of that, choosing a passively-managed fund (an ETF, for example) is preferrable – as long as there is one which matches your investment strategy. This lets you reduce the cost of investing without lowering your potential investment returns.

How much risk should I take on?

That depends on your risk capacity. The more income and wealth you have available for investing, the more risk you can take on. Important: Only invest money which you could afford to lose in a worst-case scenario.

With some kinds of investments – particularly stocks – the risk depends on the investment term: The longer the time-frame, the lower the risk. If you plan to keep the money invested for many years, then investing more of it in stocks can make financial sense. But if you expect to withdraw the invested money relatively soon, then a conservative strategy is more suitable.

How can I know how risky a fund is?

You can find a fund’s risk profile on its fact sheet or key investor information document (KIID). These documents can be obtained from the fund’s operator.

The general rule is: Stock investments have a higher risk of losing value, but also have the potential to yield higher returns than other asset classes. Bonds are considered to be less risky. Their returns are more stable, but are often lower than those of stocks over the long term.

How important are the costs of a fund?

Fund operators charge you fees to invest your money for you. Additionally, there are other costs which may be incurred when investments are made. The total costs are one of the most important factors to consider when choosing an investment fund.

What counts in investing is how much money you have at the end of the investment term. Costs are a major factor which negatively impacts the final amount. More importantly, a fund’s costs are more or less foreseeable, but there is no way to predict its future performance.

What is the total expense ratio?

The total expense ratio (TER) is the most important factor to consider when looking at a fund’s costs. The TER covers management fees, custody fees for the securities held by the fund, salaries, and the costs of rebalancing, publications, and administration. It shows the annual cost of investing with a fund as a percentage of the assets which it manages for investors.

Example: If a fund has 200 million francs of assets under management and a TER of 1.5 percent, its running expenses are 3 million francs per year. So if you invest 10,000 francs in that fund, 150 francs (1.5 percent) of your money will go towards the costs covered by the TER across a one-year period.

Typically, TERs range between 0.2 and 2 percent per year, depending on the fund. Although the TER does not necessarily account for all possible costs, it is the best guidepost for determining whether a fund is cheap or expensive.

Which other costs may apply?

Aside from the TER, a number of other costs may also apply to using investment funds:

• Custody fees: Your bank may charge you fees for the safekeeping of your fund shares.
• Sales charges: Some funds charge you a one-time fee whenever you buy fund shares.
• Deferred sales charges: Some funds charge you a one-time fee whenever you sell your fund shares.
• Transaction costs: These include brokerage fees and other costs for securities transactions within the fund.

These possible investment fund costs are explained in detail in the moneyland.ch guide to retirement fund costs. Not all funds and banks have these fees. The details pages of funds included in the retirement fund comparison on moneyland.ch clearly show which costs apply to each fund’s operator.

What does past performance tell you about a fund?

Many operators of investment funds prominently advertise their fund’s past developments on their website and catalogues. But this information is relatively unimportant when choosing an investment fund. One fund’s past performance does not provide any clear indication of its future development.

In other words, even if a fund has consistently achieved returns over many years, it is perfectly possible for it to suddenly lose a lot of value tomorrow. The opposite is also true: A fund which has made losses over a long period could suddenly achieve major returns. But you should be aware that funds with poor performance have a higher risk of being liquidated.

Are some fund managers better than others?

If you prefer actively-managed funds in spite of the higher costs, you may be wondering whether a specific fund operator has better chances of achieving returns. But as with the historical development of investment funds, there is no reason to believe that a successful fund manager will continue to outperform their peers in the future.

A study conducted by the Lucerne University of Applied Sciences and Arts and the Asset Management Association Switzerland annually evaluates the performance of active asset managers whose funds are available in Switzerland. The study showed that performance is extremely volatile: Within two years, half of the top ten providers were no longer in the top ten.

This shows that a fund manager’s past performance does not provide any real indication of how they will perform compared to their competitors in the future. That is another reason why looking at costs rather than performance is key to choosing the right fund.

What are retrocession fees?

Retrocession fees are a kind of sales commission which a fund manager pays to a bank for selling its shares. If you invest in a fund through a bank or other financial institute, it is possible that the fund’s TER also includes the costs of the retrocession fees paid by the fund, in addition to standard costs. In this case, you are paying for the sales commissions earned by your bank.

In Switzerland, retrocession fees should, by default, be passed on to the investors who own the fund shares. However, some financial services providers require you to give up your claim to that money. By signing this kind of agreement, you give them the right to keep the retrocession fees.

For the most part, Swiss asset management services no longer keep retrocession fees. But that is not true of investment funds. Unfortunately, it is difficult to recognize whether or not a fund pays out retrocession fees when choosing funds to invest in. Normally, banks and fund operators refer you to vague clauses which state that it is possible that retrocession fees may be paid. But the size and scope of actual retrocession fees is normally unclear. So there is no way to know in advance whether a part of the TER or other fees is being spent on retrocession fees.

That is why choosing the cheapest suitable fund generally makes financial sense. Once you have invested in a fund, your financial service provider has to inform you about the retrocession fees. As a customer, you can ask your bank whether an investment fund pays retrocession fees, and request to have these paid out – unless you have signed a declaration renouncing this right.

What role does the size of a fund play?

In many cases, and particularly with ETFs and index funds, it is advantageous for you as the investor if a fund’s total assets under management (AUM) are substantial. The reason is that the costs of a large fund are divided between a larger number of investors. That, in turn, can result in a lower TER.

But some funds can also be too big. Funds which invest in very small companies are a classic example. If a company’s stock is not very liquid – meaning there are not many buyers and sellers for that stock – then that company’s value can be heavily influenced by large purchases or sales of shares in an investment fund which holds that stock. That, in turn, affects the price of the investment fund – just because someone wanted to buy or sell their fund shares. In many cases, these kinds of funds stop selling shares once they have reached a certain size.

Do funds pay out dividends?

Generally, yes – as long as the fund invests in assets which yield dividends (particularly dividend stocks). The dividends are not necessarily paid out directly. It is common for funds to reinvest dividends back into the fund (accretion). Instead of getting a dividend paid out, your fund shares become more valuable

This process happens automatically. To find out whether a fund pays out dividends or reinvests them, refer to the documentation provided by its operator.

How much money can I earn with a fund?

That depends on how the fund’s investments develop in the future, which is impossible to predict in advance. So there is no sure way of knowing whether you will make a return on your investment, and how big that return will be. But you can use the fund calculator on moneyland.ch to calculate a possible total, final profit based on the returns you expect a fund to achieve (3 percent per year, for example). But here too, there is no guarantee that a fund’s actual performance will match your expectations.

More on this topic:
Compare pillar 3a retirement funds now
The costs of investing with ETFs explained
Compare Swiss stock brokers now