If you’re investing in managed funds or exchange-traded funds (ETFs) for the first time, you might feel a bit spoiled for choice. With so much to choose from, the whole process may seem overwhelming at first—but don’t worry! It’s actually pretty easy to figure out which fund to invest in.
Risks and rewards
As a general rule of thumb, higher risk means more reward. If you want higher returns, you need to be willing to accept less certainty. On the other hand, if you’re looking for more certainty, you may need to accept lower returns.
You can look to your bank for a good example of this. When your money is in your chequing account, it earns an interest rate of approximately ¾ of basically nothing (technical term). But if you put it in a term deposit, you’ll get paid a higher interest rate. This is because you’re taking a small risk. If you need to take the money out of the term deposit before the term is up, you’ll pay a fee, and end up losing some money. So the bank is compensating you for this risk with a higher interest rate.
The same concept applies to investing in funds through Sharesies. Some funds pay off more in the long run, but they go up and down a lot more in the meantime. Others grow slowly, but don’t go down in value as often.
The best way to figure out how much risk to take is to look at your time horizon.
“Time horizon” is one of those fancy investment terms that takes the long way round to describe something straightforward. In this case, it’s a timeframe. Your investment horizon is just the amount of time you expect to go by before you actually spend your money.
This obviously doesn’t need to be exact, as that would be impossible. But you should know whether you’re going to want to spend your money next week, next month, next year, or in the next few decades.
If you're going to need your money soon, you should probably avoid riskier funds. These funds tend to pay off more in the long run, but they also have a tendency to go up and down a bit in the short run.
Here’s an example: say you invested $100 in the US500 fund back in May of 2017. At that time, they were worth $6.44 per share, so you would have got 16 shares (we’re rounding up).
Those shares are now worth $6.91, so if you sold your shares today, you’d have $110. Nice!
But wait—what if you had a very short horizon, and sold your shares in August? Things were not so rosy back then, and shares were only worth $6.05 each. Your $100 would have been worth $97. You lost $3. Stink.
This shows that your time horizon matters. If you’re not cashing out when your investment is worth less than you paid for it, then you’re okay. But if you need the money, and need to cash out when things are not worth very much, then you’re going to pay a steep price for your risk. So make sure you tie your level of risk with your time horizon. Longer horizon = more risk.
So that’s really it: investing in funds is about risk and time. The more time you have, the more risk you can take. And the more risk you can take, the higher you should expect your returns to be to compensate for that return. Another reason diversification is so key! So buy, hold, and wait to get the rewards.
If you’re interested in investing in companies, check out our blog about how to choose a company to invest in.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written.