5 Tips for Investing Through Funds

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A brief explanation of investment funds

8 minute read

Investment funds are a suitable way for beginners to build up long-term assets. But how do you find the right fund and what should you consider?

 

Those seeking to save money can choose between tens of thousands of funds with varying investment strategies, emphases, and asset classes. Therefore, a decision should be well-thought out. First, you should consider the intended duration of your investment: If you want short-term investments without major price fluctuations, pension funds are a good option. However, if you plan on a long-term investment horizon and do not mind price fluctuations, then equity funds are more suitable. So-called mixed funds invest both in equities and bonds. Once you have made this fundamental decision, the next step is taking a look at performance.

A good past performance in the past does not guarantee future success. Nonetheless, it is an important indicator of the quality of the fund manager. Funds that have been able to beat their benchmark index for a long time have a good chance of continuing to do so in the future. Investors can find information on the performance of various funds in the financial press and on the Internet. To avoid comparing apples with pears, they should only look at the performance of various products within one fund category. They should keep an eye on long-term performance, i.e. preferably over a period of five to ten years, and pay particular attention to how the funds have behaved in times of crisis.

The same principle applies to investment funds as to all other financial investments: The higher the return opportunity, the greater the risk. Investors should therefore also consider the risks of the funds in question. Volatility is recognized as a measure of risk. The more volatile a fund is, the more its value fluctuates. Therefore, investors should prefer funds with lower volatility for the same return.

Volatility is usually given for a period of 60 days, for example. A value of 20, for example, means that the daily yield over the last two months has deviated by 20 percent from the average. A volatility of 0 would indicate that there has been no price change. The higher the value, the more the prices fluctuate. Similar to the performance of a fund, the volatility also says nothing about future fluctuations. However, a high value increases the likelihood that the fund's price will continue to fluctuate strongly in the future.

 

After finding a desirable fund, the next question is whether to invest in a distributing or reinvesting share class. Ultimately, this is a matter of preference. In distributing funds, income is distributed to the investors regularly. In dividend funds, for example, distribution can be considered an attractive additional income. Accumulation funds, on the other hand, reinvest the income in the fund and thereby increase the value of the fund units.

 

Surveys have repeatedly shown that German savers ignore low-interest rates and continue to rely on fixed-term deposits and savings books. They tend to avoid equity investments due to the fluctuations that are characteristic of the stock market. However, patience with the stock market can create a small fortune from even a modest sum.

Fund savings plans are also suitable for long-term asset accumulation instead of or in addition to a one-time investment. Funds have many advantages such as flexible savings rates and no fixed terms. The cost-average effect is particularly notable: Fund owners even benefit from stock market fluctuations. When saving through funds, one "outwits" the so-called pork cycle. Thanks to the self-imposed, fixed purchase rhythm one receives many shares in times of falling markets (i.e. buy cheaper) and consequently only a few shares in times of high prices. This means: One invests extensively when shares are cheap, thus acquiring many shares that also experience an increase in value when the market rises again. Conversely, one invests cautiously during rising markets and thus acquires fewer shares when they are expensive. This way, fewer shares drop below their cost price when markets fall.

The cost-average effect can easily be used in the form of a fund savings plan into which constant installments are paid each month. However, every installment counts as a fund purchase. This means that one pays the usual issue surcharge for the industry every month. These costs eat away at the return, which is why it is worthwhile to use the permanent discounts of fund brokers, leading us to the next point.

 

What many investors do not realize: Investing money always involves certain costs - be it deposit fees, the issue premiums for investment funds, or trading costs. These costs eat up your return especially if you set up your securities account with a classic bank. This is because financial institutions have to finance their network of branches and the advisory services they provide; therefore, they are well paid for their services. Online direct banks are much cheaper and are even cheaper if a fund broker is "interposed." Investors who already have a portfolio do not have to cancel it in order to profit from the savings tariffs of the fund brokers - a simple change of broker is sufficient and the special conditions are activated immediately and permanently.

In principle, there is nothing wrong with placing orders through a securities account. However, fund investors should be aware that the fund company generally charges an issue premium of five percent per purchase. The initial sales charge is the sales commission on the purchase of units as calculated by the fund company. Some funds have two prices, an issue price and a redemption price. Here, the fund units are sold at the issue price and repurchased by investors at the lower redemption price. The difference is called the bid-ask spread. The issue and redemption prices are the same for funds with only one price. The initial sales charge generally amounts to around five percent of the investment amount. The fund must first recover this amount.

The initial sales charge reduces your investment sum and thus also your fund yield. In contrast, the initial sales charge does not apply to more than 20,000 investment funds when using a fund broker - easy and without additional costs or notice periods.

 

You have checked with the industry media or experienced investors to find out which fund is right for you and decided on the fund of your choice. You can save yourself expensive initial and custodial fees if you choose a fund broker. A professional fund manager manages your capital - while you can sit back and relax. However: Anyone who lets his portfolio rest quietly runs the risk of wasting money.

Stay active, therefore, or you may waste money or miss out on interesting opportunities for profit. It is advisable to regularly check your portfolio. Experts advise you to check your securities accounts at least once a year - more often in the event of a change in your life and income situation or in the event of market turbulence affecting your fund's investment environment. You should pay attention to the following aspects:

  • Define a personal investment objective: What course would you like to achieve? Are you primarily concerned with profits or value retention? Which fluctuations in value (volatility) are you prepared to tolerate? Be clear about your motives and always keep them in mind.
  • Limit your losses: Set yourself a limit at which the investment is no longer worthwhile for you. If your fund reaches this loss limit, find out whether there is any prospect of a recovery in the share price or whether it is advisable to sell your shares.
  • The buying rates decide: You can only judge whether you are in the profit or loss zone in the long term by comparing your investment total less all costs. Therefore, keep the purchase receipt in a safe place!
  • Use tax allowances: As a saver, you have an allowance of €801 from investment income at your disposal. No taxes are due even if you have an exemption order or a non-assessment certificate. Therefore: It is best to place an exemption order right away!
  • The annoying paperwork: As with all important documents, the principle "order pays off" applies here too. In order to have everything ready for your tax return, you should carefully maintain your correspondence with your fund company, custodian bank and fund broker.

 

Do you have a question about asset accumulation with investment funds? Write us a comment below!

 

 

About the author: Thomas Soltau has been active in funds since 2003 and knows the industry, especially the behavior of customers, better than most. With this background, he began his career at FondsDISCOUNT.de in 2006 and was appointed Chairman of the Management Board on 1 January 2014. Since then, he and his team in Berlin have concentrated on company development, maintained intensive contacts with investment companies and issuing houses, and continued to be active in customer service.

The DISCOUNTER principle: "High quality at the best prices" is the motto of FondsDISCOUNT.de. Private investors can use the fund broker to avoid the initial sales charge for more than 20,000 funds and receive discounted custody account conditions at all partner banks. The service is permanently free of charge for customers.


 


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