How do you go about choosing a fund ISA (individual savings account)? Find out how to navigate fund ISAs and decide between tracker or managed funds, and the importance of charges.
Choosing a fund to put in your ISA can be daunting. There are around 3,000 unit trusts, open-ended investment companies (OEICs) and investment trusts and to choose from. But don't panic. Here are some guidelines to help you weed out the undesirables and make the choice more manageable.
Tracker or Managed?
As we explain in the Tracker Centre, index trackers beat 3 out of 4 managed funds over the long term (5 years or more). This is primarily due to the fact that their charges are lower. But if you want to beat the index then you will need to choose a managed fund although bear in mind the odds of beating the index are against you.
The Importance of Charges
All else being equal, and it usually is, a low cost fund will tend to perform better than a high cost one. Some funds charge up to 5% in initial fees and 1.5% or more in annual fees. As a group, investment trusts tend to have lower charges than unit trusts, although their performance tends to be more volatile.
It's easy to assume that the odd 1% here and there doesn't make much difference. But this is definitely not the case. A fund that grows at 10% a year for 20 years will give you 24% more as a final sum than a fund that grows at just 8.5%. Initial charges can quickly take their toll, especially if you tend to switch funds every few years.
Whenever you buy a fund make sure you look at the Key Features document that accompanies your application. This has to detail the charges in all their gory detail. Quite often you'll find that there are additional charges on top of those mentioned in the headlines of the adverts. Make sure you do not get caught out. In addition, the Financial Services Authority (FSA) has begun to publish Comparative Tables that show the effect of charges for some of the most popular funds on the market.
Beware of Past Performance
Plenty of research has been carried out on whether past performance is a good indicator of future performance. In English this means: should you buy a fund because it has done well in the past? The answer turns out to be no. Which is ironic, really, because evidence shows that most of us do choose our funds on this basis, not least because of the flashy performance statistics that are the main feature of fund adverts. If that wasn't bad enough, the adverts are often rather selective about how they present the data, flattering the true performance of the funds in question. In reality, periods of good performance are often only temporary and will often be followed by periods of poorer performance.
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