Last week, a client of mine asked me to breakdown into plain English what he had investments in through his original investment manager. He had just let the manager invest on his behalf, but he really didn’t understand what his portfolio was and how it worked.
After having a proportion sitting in cash (always a good idea), the rest was split between different types of mutual funds. There are basically two different types of fund, but how these are used and funded differ immensely, and the client needed to understand this.
A fund is a type of investment that allows multiple people to join their money together to purchase into different securities such as equities, commodities, bonds or property. Each fund has a different aim and usage, whether it’s for growth or for income. They can also be categorised by where in the world the underlying stocks or bonds are from.
These can again be split into two areas of actively managed and passively managed. Actively managed funds will have either an individual or a team picking and choosing what to buy to be placed in the basket of the fund. Passively buys into an index or commodity, providing that investor with the same returns as the underlying market.
The client didn’t understand the bond provision as he said he didn’t want to have any borrowing in his portfolio. I had to explain that he was not actually borrowing money to feed his investments; it was the other way around.
Again, his bond holdings were in a fund, meaning he had exposure to a number of bonds. Bonds are at heart an ‘IOU’. Bond issuers can be either governments or companies and it is a way for them to raise money without having to borrow against a bank or offering a share release. You lend the issuer money and they say they will pay you back on a set date with regular interest paid throughout the term. The more chance of the bond not paying back, the higher the interest will be.
These again can be bought and sold by an investor, and for easy access for private investors, they are bundled into funds. These can be classified at the lower end of the risk scale if picked properly and should be part of the client’s portfolio, as he is not using borrowed money (leveraged) to fund his plans.
If you are at the lower end of the risk spectrum, please have a look at bond mutual funds for a proportion of your investments. Not all of it, just a proportion to keep it balanced.
Paul McLardie is a partner at Total Wealth Management. Contact him at Paul.firstname.lastname@example.org