As an investor, you are likely familiar with mutual fund investing. It’s an easy way to diversify your investment holdings, so the risk is spread out over several different kinds of investment vehicles. However, did you know that mutual funds can invest in other mutual funds?
Mutual funds can invest in other mutual funds, which is called a Fund of Funds or FOF. You gain diversity by investing in mutual funds. Then, you gain even greater diversity by investing in a mutual fund whose holdings are other mutual funds.
Small investors see real benefits by buying into a mutual fund of mutual funds, but this type of fund is not meant for everybody. We’re going to explore the benefits of a FOF and what, if any, are the drawbacks.
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Fettered and Unfettered FOFs
There are two types of FOF mutual funds: fettered and unfettered. A fettered FOF mutual fund means the fund only includes investments sold by the same management firm. If you invest in a Vanguard Mutual Fund of funds, all the mutual funds in your portfolio are also sold and managed by Vanguard.
You will pay one management fee.
An unfettered mutual fund invests in its group of funds as well as those of other managers, which is less restrictive. However, you will be paying management fees to multiple managers.
Why Does Your Mutual Fund Investing Style Matters?
Your mutual fund investing style may fluctuate with your life stages and investment goals, and how much risk you can tolerate will define whether your style is conservative, moderate, or aggressive.
Your investment manager will assist you with selecting mutual funds to add to your FOF that fits your investment style. But the beauty of mutual funds is the opportunity to expand your investing style to incorporate more risk because the investment is diversified.
If you choose to invest in a mutual fund, your fund manager helps you select your stocks and bonds.
Your portfolio manager will select some investments that may grow slowly but provide a superior return over time. They might also choose others that are ready to pop which will give you a quick high return. Still, others are so safe and sure that they barely fluctuate over time, providing a dependable, though smaller, return on your investment.
Research Your Fund Managers
Mutual funds are selected and traded by highly successful fund managers. Researching the fund manager’s qualifications, investment style, and success history are essential before buying into a mutual fund.
Your fund may be handled by one or manager or a team of people, as they will determine the best strategy for investing and trading on your behalf. Their strategy should reflect your investment style and goals.
The manager’s fee is based on a percentage of the fund assets.
Mutual Funds of Mutual Funds Are A Good Choice for Inexperienced Investors
Do you want to get into mutual fund investing, but are unsure of where to get started? Mutual funds of mutual funds might be a good place for you to start, as they might present less of a risk than other mutual funds or investment opportunities.
Let’s take a closer look into why these are a good choice for you.
- FOFs are attractive to new and inexperienced investors and those with smaller sums available for investment. How well you research your fund based on management will affect your rate of return on what may be a minimum investment.
- The average required investment to buy into a mutual fund is $1000. If you have $1000, you can only buy into one mutual fund that experienced professionals manage.
- Unless you buy into a mutual fund that is a fund of mutual funds. Now, instead of having your investment dollars diversified over five stocks and bonds, your investment is diversified over five funds of five or 25 different stocks and bonds.
Choose a fund with impressive performance history and an accredited fund manager whose skill will serve you well.
Know the Mutual Fund Categories and Their Risks
Your fund manager will select from the fund categories to include investments for your FOF based on your investment style. There are no guarantees, and there is a degree of risk with all investments due to market fluctuations and external influences.
Here are some of the fund categories that your fund manager will choose from:
- Money market funds are short-term and low risk.
- Stock funds carry more risk, so the expected return is high.
- Bond funds are low risk but perform better than money market funds.
- Balanced funds are a combination of higher-risk stocks for growth and lower-risk debt bonds for income.
- Sector or Speciality funds are often high-performing and have a place in a diversified portfolio that can balance the greater risk. Real estate, technology, pharmacology are examples of specialty funds.
- International Funds can add another layer of diversity to your portfolio.
Diversity and capable fund management are vital to protecting your investment while building wealth.
Resist the temptation to manage your portfolio, especially if you are new to investing. A hot tip might make you a millionaire, but it’s more likely that you will wake up broke without a balanced strategy.
What Is a Hedge Fund of Hedge Funds?
Hedge funds are less regulated and carry greater risk, so not everyone can invest in them. Only accredited investors can invest in hedge funds, which means the investment fund managers will investigate to be sure you place in a higher income bracket of at least $200,000 annually or have assets worth 1 million.
A hedge fund of hedge funds will allow those with less than the 1 million buy-in cost to participate in the fund for less. Traditionally, hedge fund returns are greater than mutual funds, but then the fees and the risk are higher.
Can You Have Too Many Mutual Funds in Your Mutual Fund?
Too much diversity is possible, as you can spread the risk so thin that your returns become minuscule, and the risk of duplication is high. There is also the cost of managing such a large number of individual investments. Your management fees could exceed your profits, so invest according to your goals, short term, and long term.
A renowned investment manager is your best source of fund strategy.
A Few Negatives Associated With FOFs
Depending on the type of mutual fund of funds you select, you could be paying fees on fees. You pay your fund manager to manage funds that other managers manage, who also charge a fee.
Let’s take a look at some of the other negatives associated with FOFs:
- There is more homework for the investor with a mutual fund of mutual funds. Even if you are confident in your manager, you want to familiarize yourself with the prospectus of each investment in the fund. If you feel the need to follow each, it’s going to cut into your free time.
- Even if you only have one fund manager in charge of your investments, choosing that one manager is a leap of faith. Even when his or her past performance is stellar and the brokerage firm is high profile.
- Selecting a mutual fund manager is your first investment risk. Keep that risk low by doing your due diligence before investing your money.
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Conclusion
Despite the risks, a mutual fund of mutual funds is an excellent investment vehicle for investors at all levels of experience.
- It allows a broader selection of primarily stocks and bonds in your portfolio, which increases your opportunities for returns. The risks are also lower due to the diversity.
- A mutual fund of funds is a less demanding strategy for investing. Once you’ve selected the fund and manager, you can forget about it.
- You’ll want to check the growth from time to time and adjust your goals and investment style. Otherwise, it is a low-maintenance method of investing.
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