When planning a strategy for your finances there is one golden rule - that you should have a spread of investments to be safe from inflation, fraud, accident, bad luck and poor judgement.
However smart you are the unexpected always happens, so you should guard against being wiped out in a single catastrophe by spreading your risk across several funds, or by choosing a fund manager with an investment strategy that is in line with your goals.
Growth and income
At a very basic level investors face a choice between two basic types of funds, those designed for capital growth and those that produce current income. Growth and income funds both invest in equities, but they usually perform differently.
Income funds invest in shares that pay above-average dividends, and tend to do relatively well in a downturn when investors want the security of a decent payout. Growth funds, which tend to chase short-term trends such as the tech bubble in 1999, usually perform better in a market upswing. Advisers suggest a blend of both in your portfolio.
Broadly speaking younger people are saving for the long term and don't necessarily need their investments to produce a current income but will be looking to guard against inflation. Under these circumstances advisers say growth funds are usually best; these aim to provide a growing capital sum, usually at the expense of a high current income.
For middle-aged investors, growth funds are still normally the right thing, but the amount invested is likely to be larger as a result of higher income and savings accumulated over previous years. With a secure capital base behind them, middle-aged people may also consider putting part of their savings into some of the more risky investments such as some of the more specialised pooled funds.
When investors start to approach retirement, their priorities change. Having built up a capital sum they will need to start switching towards funds that will provide an income once they stop work. Retired people are also less able to take the knocks that can come from growth funds - for although share based investment funds tend to do well over the long term, they can swing in value over the short term. So people of that age will start to switch into income funds.
A good place to start trying to match the stock market's performance is with a general UK equity fund that will tend to invest in a broad range of UK shares. For those looking for slightly more risk growth funds will try to beat the market. Not all parts of the stock market perform equally well at the same time, so the trick is for the manager to pick the next boom area. In pooled investments there are many funds that concentrate on specific types of share - for example smaller companies or technology stocks. If the manager picks the right area, they can beat the market, but at the risk of under performing if the decision is wrong.
Special situations
One area liked by fund managers seeking growth is recovery funds. These are funds investing in shares which have fallen on hard times, but which are not expected to go bust; as the companies recover from their difficulties their shares can do very well.
Another group of funds that try to beat the index are so-called special-situations funds. These invest in unloved, under-researched companies, and can be risky. There are always likely to be companies that are undervalued and managers who can spot their recovery potential.
It is important not to be swayed by fashion. If a particular area of the stock market or an overseas market is doing outstandingly well, a number of new funds will be launched to exploit the boom. Plenty of hype goes into these new launches but this may not last long.
