How to select an investment fund that best suits my risk profile

An investment fund is an affordable investment vehicle for any investor, although it is important to know which one is most appropriate for a particular situation.

One of the most popular investment vehicles for both experts and newcomers in these matters are investment funds. Since they are not complicated to understand, all financial institutions (banks, savings banks, etc.) constantly market them. Moreover, most of their clients are trained to quickly grasp what their benefits are and how they can improve their wealth in the years to come.

All investment funds are not the same, nor are all possible participants the same, so as well as understanding what this financial vehicle comprises, you must know how to select the most appropriate one, i.e., the one that best fits your needs.

 What are investment funds?

In answer to the first question, mutual funds are collective investment vehicles in which each participant's contributions are grouped to make better investments of their savings.

As a result, a greater amount of capital is available to allow better conditions during the investment process. Furthermore, if each participant were to try to perform them on their own, it is unlikely that they would succeed.

How safe are investment funds?

As a preface to examining the factors that must be considered in choosing an investment fund, it is important to refer to the safety of such financial vehicles. Consequently, since it is a financial vehicle, subject to market fluctuations, it cannot be guaranteed that participating in one will be profitable.

They are safe for two reasons: Firstly, because they are managed by professionals who are interested in the mutual funds rendering profits; and secondly, because they are all regulated, in Spain, for example, the CNMV (National Securities Market Commission) ensures that all liquidity, transparency and diversification requirements are met.

Choosing an investment fund

Having decided to join one of these funds, you will have to make the following important decision: choose the fund that best fits your profile. However, this isn't as straightforward as it may sound, as there are several factors to consider.

Most importantly are the following: What objectives does the investor have?; What are their specific personal circumstances –which may differ from the investor's objectives–?; What is the period in which they intend to invest?; Which advisor will manage the fund; What fees are involved?; And what is the history of the fund?

Investor objectives

There is no question that the first step that any investor should take is to identify their objectives. This is very important, as it will help the specialist to suggest one type of fund over another. A medium-term investment to buy a second home is not the same as a long-term investment to build equity for retirement. Here are two examples that demonstrate how the choice should be based on personal desires and needs.

Investor profile

The second item on the investor’s checklist is to be consistent with their personal circumstances and to know themselves well before taking on risks. On the one hand, a sound personal financial situation is necessary to make such an investment. Furthermore, you will need to evaluate yourself in order to determine the extent to which you would be willing to take risks. For this purpose, there are tests that determine the suitability and convenience of each investor. By doing so, you can determine the risk profile and accordingly choose the most appropriate funds.

Investors must also determine when they will be able to obtain a return on their investments if they want to do so ahead of time. This is called liquidity, and not all financial vehicles have the same liquidity, therefore, you have to consider it from the outset.

Investment horizon

Depending on the period of time you wish to invest, you will need to choose a specific fund. If you choose a short-term investment, the most common option is to invest in a fixed-income vehicle or in a model that has less swings and is less volatile. By doing so, you do not have to take significant risks. In contrast, when opting for the long-term, the most common investments are usually of variable income which, although they are more volatile, tend to be more profitable. As a general rule, the economy tends to grow over time, so if you have enough time you will probably make a profit.

As for funds, it should be noted that there are many different kinds, although Juan Puente outlines the most important ones on Fondos.com based on the investor’s risk profile:

• Low risk investor, low-risk funds for capital preservation and non-high return investments. "For this investment philosophy, funds that build their portfolios from fixed income assets (bonds, bills, debentures, commercial paper, etc.) are recommended."
• Balanced investor. You take some losses, but you also gain some profitability. “Mixed funds (those that have fixed income and variable income in their portfolios) are suitable for this type of risk profile.” The expert suggests investing in the mixed fixed income or mixed variable income fund category.
• Aggressive Investor. Suitable for those seeking high returns, even if they must take greater risks to do so. "These investors may opt for the category of variable income funds. Possibly in foreign markets and fields with potential profits (such as technology)."

Fund history and information

Another important factor to consider when choosing an investment fund is its history. In an article published by Rankia, Enrique Roca explains it as follows: “It is important to review at least the last five years' history of the fund and compare its performance with that of the market. Observe when the market returns to its previous high following every drop. Examine the evolution of the fund, compare the date of the fall with the date of the recovery of the last high. If the net asset value of the fund is higher than its previous high, it indicates that it has outperformed the market and that the manager has produced alpha or profit for you. This is a simple rule, but it works."

Fees

Identifying the various fees associated with each investment fund is another aspect to consider before selecting one. Choose a fund with low fees, since this will offer you higher returns and earnings. Of course, it does not always have to be an essential component, since there can be funds of low quality and profitability that carry low fees, and even then, they are not worthwhile.

Fund manager

Last but not least, you should be familiar with the history of the management team. Of course, they have to be outstanding professionals, since it is dependent upon them whether the fund achieves a higher or lower profit level. When they are part of the fund, their interests are aligned, and this indicates that they will always try to make the right decisions.

Additionally, it is advisable, as far as possible, to maintain an active relationship with the manager of the chosen fund, in order to gain a better understanding of their investment philosophy.

These are the most important considerations to bear in mind when selecting an investment fund. The best decisions can be made only with accurate data and information.