Investors are failing to take into account important allocation, cost and tax considerations when choosing funds, according to a survey by the Association of Investment Companies (AIC).
More than a third of investors believe that performance is the single most important consideration when choosing a fund, when in fact portfolio composition should be by far the most important consideration, says the AIC.
The second most influential factor when choosing a fund among investors surveyed by the AIC is the fund manager, with nearly a quarter (24 per cent) of respondents believing this to be the most important issue. Their third highest consideration (16 per cent) was the portfolio composition, while charges ranked only fourth.
"Research shows us that the way to control variance in returns is to identify and control the asset allocation, or the range and types of investments bought inside a portfolio, as this is what drives the returns achieved," said Jacqueline Lockie, head of training at the AIC, who is also a certified financial planner. "It's all about risk. For example, you may be interested in a small-cap fund as it has the best performance record, but this would be more risky than perhaps a blended fund with a mix of asset classes. This small-cap fund might be wholly inappropriate for you from a risk point of view, and you might experience larger fluctuations in value than you are used to."
The second most important consideration when choosing a fund should be charges as these drag back performance. For example, if a fund increased by 7 per cent in the past year but the total charges were 1.5 per cent, the returns to the investor would be only 5.5 per cent. The bigger the charge, the harder the fund has to work to stand still.
"Investors need to establish what the ongoing charge is and then look at the cost for buying and selling, and any associated administration charges," advises Ms Lockie.
And if you are looking at either country-specific or sector-specific funds, then geographical weightings should be a consideration. If you were interested in a UK fund, it would be important to ensure that it included a good spread of all the sorts of industries and sectors that represent the UK. This would mean that the returns fairly reflected the UK and you wouldn't miss out on a high-returning sector.
This comes as research from insurer Prudential shows that 31 per cent of investors in a survey weren't aware that the way they buy financial products - direct from a provider, or from a platform or fund supermarket - can impact the cost of their investment.
The findings also suggest that many investors are failing to consider important taxes and charges. Almost half (44 per cent) admitted they didn't know which wrapper product would be most appropriate for their circumstances, 37 per cent weren't sure how to avoid tax traps and nearly a fifth weren't confident that they would keep under their annual capital gains tax (CGT) threshold, £10,900 for the 2013-14 tax year.
Using the CGT threshold correctly helps investors maximise returns in a tax-efficient way. However, despite most survey respondents (81 per cent) saying they understand CGT, only 28 per cent knew that the allowance was £10,600 for 2012-13, with 13 per cent overestimating it.
"Investing in a tax-efficient way is not something that happens automatically," said Matthew Stephens, tax expert at Prudential. "Investors can save substantial amounts by maximising exemptions and limits, using individual savings accounts (Isas) and the CGT annual exemption, for example, as well as other tax-efficient investment vehicles."
