Investing in a fund of funds is never a bad idea. A fund of funds is indeed a safe and smart choice to make when it comes to investing your hard-earned money.
But as they say, ‘Read all scheme related documents before investing’, it is extremely important for you to know some of the most basic and important facts like what exactly a fund of funds is, how is your money going to get invested, what should be the term of your investment, what kind of returns can you expect, etc.
So, what exactly is a fund of funds?
Fund of funds is basically a different type of mutual fund that invests in other mutual funds instead of directly investing in stocks, securities, commodities and bonds.
For example, when you invest in a particular mutual fund, that particular mutual fund further invests your money directly in the market. But, when you invest in a fund of funds, the fund of funds invests your money in various mutual funds and then those mutual funds invest in the market.
How does it operate?
There are various types of funds like multi-manager funds, gold funds, international funds and asset allocation funds that operate at varying degrees of risk in order to match the varying requirements and the risk profile of the investor.
If the primary requirement of the investor is to get high returns, the fund of funds will invest in mutual funds delivering high returns which will also have a higher degree of risk and vice versa.
Pros and cons
A fund of funds is undoubtedly a safe choice to make when it comes to investing your hard-earned money. The diversification of your investment across several funds from various sectors along with thorough professional management by expert fund managers ensures minimum risk on your investment.
Moreover, the collective investment strategy of the fund of funds also enables you to invest in some of the top-performing mutual funds even with a limited investment budget. Also, when the fund manager rebalances fund of funds between equity and debt, there will be no capital gain tax for the investor.
Just as every coin has two opposite sides, investing in a fund of funds also has a few disadvantages like high management fees, over-diversification and duplication of the portfolio, lack of transparency and lesser returns compared to direct investment.
One major disadvantage is the taxation process related to the liquidation of a fund of funds. Even though FOFs may invest money in equity-oriented funds, it is taxed as a non-equity fund which is not very tax efficient.
Should you invest?
If you are a budding investor having limited knowledge about the market, minimum investment budget and looking for a long-term and diversified investment option with limited risk, then yes, you should invest in a fund of funds. But if you are an experienced investor and willing to take the extra risk to get higher returns, then you must invest directly in stocks, securities, commodities, mutual funds and bonds.
(The author is Chief Belief Officer & Founder of Fintoo. Views are his own)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
FAQs
An FOF spreads out risk. Whereas owning one mutual fund reduces risk by owning several stocks, an FOF spreads risk among hundreds or even thousands of stocks contained in the mutual funds it invests in. FOFs also provide the opportunity to reduce the risk of investing with a single fund manager.
Is it good to invest in funds of funds? ›
Advantages of Investing in Fund of Funds
Fund of funds target various best performing Mutual Funds in the market, each specialising in a particular asset or sector of fund. This ensures gains through diversification, as both returns and risks are optimised due to underlying portfolio variety.
What is the difference between a fund of fund and a mutual fund? ›
Mutual funds invest in different securities, like equity and debt instruments. They invest in a company's stocks and debt papers on behalf of their investors. The FoF invests in other mutual funds.
What is the disadvantage of investing in a fund of funds? ›
Costs and fees: FOFs generally come with additional layers of fees. Investors might face the fees associated with the FOF itself and the fees of the underlying funds within the portfolio. These cumulative expenses can eat into overall returns, potentially reducing the net gains for investors.
What is a better investment than mutual funds? ›
Overall, ETFs hold an edge because they tend to use passive investing more often and have some tax advantages. Here's what differentiates a mutual fund from an ETF, and which is better for your portfolio.
How risky is investing in funds? ›
Funds with the lowest risk profile are the least volatile and funds with the highest risk are the most volatile. If you're a cautious investor, you may only want to take a small amount of risk to try and achieve a modest and relatively stable return. If so, funds with a low risk profile could be right for you.
What is the riskiest type of fund? ›
Equities and equity-based investments such as mutual funds, index funds and exchange-traded funds (ETFs) are risky, with prices that fluctuate on the open market each day.
Which is better trust fund or mutual fund? ›
Unlike mutual funds, investment trusts can take on gearing, or borrowing additional money for investments, which unit trusts are not allowed to do. That means they can take bigger risks, meaning potentially bigger rewards or potentially bigger losses.
How much does it cost to set up a fund of funds? ›
A typical FoF fee would be “1 and 5”, which means a 1% management fee on your investment plus a 5% performance fee on the gains from the investment. Similar to individual funds, most FoFs also have to meet a certain hurdle rate in order to receive their share of the performance fee, also known as 'carried interest'.
Are mutual funds worth having? ›
Many people see mutual funds as a great investment vehicle. Consider the advantage: Because they're funds that contain a variety of assets, you get automatic diversification. If Company A's stock crashes, you'd lose a lot if you were directly invested in it.
FOF Disadvantages
Overall, fees for FOFs are typically higher than those of individual funds because they include both the management fees charged by the FOF and those of the underlying funds. This doubling up of fees can be a significant drag on the overall return an investor receives.
What is downside in mutual fund? ›
Downside risk is a general term for the risk of a loss in an investment, as opposed to the symmetrical likelihood of a loss or gain. Some investments have an infinite amount of downside risk, while others have limited downside risk.
What type of risk would it be to invest in a mutual fund? ›
While mutual funds offer potential benefits, investors also face risks like market fluctuations. Market risk is a primary concern as the value of securities can go up or down based on changes in market conditions.
Is S&P 500 a mutual fund or ETF? ›
Index investing pioneer Vanguard's S&P 500 Index Fund was the first index mutual fund for individual investors.
What is the best mutual fund to invest in? ›
Below are some of the best mutual funds, with performance data as of March 29, 2024.
- Victory Nasdaq-100 Index (USNQX)
- Shelton Nasdaq-100 Index Investor (NASDX)
- Fidelity Large Cap Growth Index (FSPGX)
- Schwab U.S. Large-Cap Growth Index (SWLGX)
- AB Large Cap Growth Advisor (APGYX)
- T.
- Fidelity 500 Index Fund. : Best overall.
- Fidelity Large Cap Growth Index Fund. : Best for growth investors.
- Fidelity Investment Grade Bond Fund. ...
- Fidelity Total Bond Fund. ...
- Vanguard Wellesley Income Fund Investor Shares. ...
- Schwab Fundamental US Large Company Index Fund. ...
- Schwab S&P 500 Index Fund. ...
- Vanguard High-Yield Tax-Exempt Fund.
It can depend on a number of factors including the number of funds you're comfortable monitoring in your portfolio, your investment objectives and risk appetite. While it's important to have a mix of styles and strategies to achieve diversification, that doesn't mean you need a long, unwieldy list of funds.
How many funds should you be invested in? ›
You should therefore only keep as many funds in your portfolio as you're comfortable monitoring. For example, if you hold 10 or 20 different funds, you'll need to keep a close eye on the changing value of all these investments to make sure your asset allocation still matches your investment goals.
What is the advantage of investing in a fund of mutual funds? ›
Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund's daily net assets.
What is the typical fee for a fund of funds? ›
Funds of funds structure and fees
The FoF charges investors a fee on top of the individual funds, which is similarly structured, though lower. A typical FoF fee would be “1 and 5”, which means a 1% management fee on your investment plus a 5% performance fee on the gains from the investment.
