Part Five: How To Select A Fund
We’re on the home stretch! So now you’re excited about the possibilities investing could open for your child, and you have a general idea of the approach you want to take. In this, the fifth and final instalment of our investing series, we get to the pointy end of things - selecting the actual investment. We can't tell you what to invest in, but we can teach you how to think about it.
Independent financial advisor Chelsea Traver, CFA from Evergreen Advice has co-created this guide with us on the key considerations when evaluating a fund. We’ve focused on funds because they are well-suited to time-poor parents who want to take a more hands-off approach.
You're potentially investing hundreds, if not thousands, of dollars over the course of many years for your child’s future benefit, so spend the time to do your due diligence upfront and review it annually at a minimum.
Note: Picking individual stocks tends to be more time intensive, and there are many schools of thought. If this is something you want to do, you could start out by carving out a small amount of "play money" that you're happy to lose so you can learn by doing.
Criteria 1: Fund Type
When it comes to the type of fund, you need to make three decisions:
The level of risk: funds fall into one of five categories: Defensive (least risky), Conservative, Balanced, Growth and Aggressive (most risky).
The risk you select can have major implications for how much your child will have when they access the investment - and also how much the investment could fluctuate up and down in value.
At one end, the goal of a Defensive fund is to preserve your investment, even if it means potentially lower returns. And at the other end, the goal of an Aggressive fund is to maximise returns, even if it means you experience more frequent and larger drops along the way. Conservative, Balanced, and Growth funds lie on a spectrum between these two.
Risk is influenced by how much the fund invests in low-risk, low-return defensive assets (sometimes referred to as “income assets” and include cash and bonds) and how much is put into high-risk, high-return growth assets (e.g., shares, property). You can use the Sorted Risk Profiler to gauge what might be right for you (you’ll notice we refer to Sorted a few times in this article - we like it because it’s an independent government-backed website with no conflicts of interest).
| Risk Level | Average Annual Expected Return | Potential Value of $100 Invested for 10 Years | Expected Range of Annual Returns | Minimum Recommended Investment Timeframe |
|---|---|---|---|---|
| Defensive | 3.1% | $136 | -1.3% to 7.7% | 2 to 3 years |
| Conservative | 4.5% | $155 | -1.1% to 10.3% | 4 to 5 years |
| Balanced | 5.9% | $177 | -2.8% to 15.2% | 6 to 8 years |
| Growth | 7.1% | $199 | -4.9% to 20.7% | 9 to 12 years |
| Aggressive | 8.3% | $222 | -7.2% to 26.4% | 13 years + |
Source: Sorted. Returns are before fees, taxes and inflation. The Potential Value of $100 Invested for 10 Years is based on the Average Annual Expected Return compounded for 10 years.
Active or passive approach (Part 3 summarises the two approaches).
KiwiSaver, a general unlisted fund or an ETF (Part 4 has a handy decision playbook to help you determine the right fund format for you).
These three decisions will narrow down the universe of investments. For example, you may decide on aggressive, passive ETFs or balanced, active general unlisted funds or growth active KiwiSaver.
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For KiwiSaver and general unlisted funds, you can use the Sorted Compare Tool to create a shortlist by filling in the fields “Show Me”: KiwiSaver or Managed Fund (the equivalent of a general unlisted fund) and “Fund Type”.
Pro-tips: if you’re looking for a fund that invests on your behalf in multiple countries and sectors, change “Single class funds” to “Excluded”. Also, while the Sorted Tool doesn’t enable you to filter by active or passive approach, passive funds tend to have lower fees, so if you “Sort by: Fees (lowest first),” the passive funds will likely be at the top.
SmartShares offers 35 ETFs in New Zealand, including access to overseas markets. There is a much broader range of ETFs listed abroad (particularly in the US), which Kiwis can access via Hatch, Sharesies, Interactive Brokers and Stake.
Criteria 2: Where is my money going?
You want to understand where your returns would be generated from in each fund. You can find this information on the fund’s webpage.
Questions to ask:
What’s the exact split between defensive and growth assets? Even though two funds might have “Growth” in the title, one fund might have an allocation of 65% growth assets, and the other fund might have 95% in growth assets - that’s a big difference in the risk-return profile. Again, the Sorted Compare Tool can give you a quick overview.
How concentrated is the portfolio, i.e. how much of the returns will be driven by a handful of holdings? Sometimes you’ll find that the top five holdings make up more than 25% of their total investment.
What is the fund’s geographic and/or sector exposure? You might have a view on which regions or sectors (e.g., banking, manufacturing) you want more or less exposure to.
Are there any responsible investing concerns? Here’s a guide from Chelsea to figure out how ethically invested the fund actually is. As a first step, Mindful Money enables you to see the areas of concern in one of two ways:
You can check specific KiwiSaver and general unlisted funds one by one to see what’s under the hood of each fund, or
You can input how you stand on key ethical considerations (e.g., weapons, animal testing, and fossil fuels, to name a few), and Mindful Money can return a shortlist of KiwiSaver and general unlisted funds.
Criteria 3: Performance track record
For your shortlist of funds, you want to look at how they have performed over time after tax and fees over the longest time frame possible, i.e. look at the last five or ten years rather than just the last year.
Questions to ask:
What is the average historical performance, and is this in the ballpark of what I'm looking for? Keep in mind returns can fluctuate from year to year, and every fund manager has bad years.
Has the fund outperformed or underperformed the benchmark? Active funds aim to outperform their benchmarks, while passive funds aim to match the benchmark (although there's generally some leakage because of fees and taxes).
Do not use past performance alone to select the fund. A Yale study found that from 1994-2018 there was no statistically significant difference in future returns between funds that performed well and funds that performed worst over the previous year.
Criteria 4: Fees
Fees are what you pay someone else to manage your money for you. Small differences can matter. For example, a 0.5% difference in fees over a 10-year period will result in a total return gap of ~5% from fees alone.
Questions to ask:
How much will I be paying in management fees? This typically ranges from 0.1% to 2% per annum, although there are funds that charge over 4% per annum
What other fees might I be paying? This could include performance-based fees, entry or exit fees and membership fees.
Have the higher fee funds outperformed the lower fee funds after tax and fees over the longest time horizon of data? Higher fees don’t always mean you will get higher returns.
Again, the fund’s webpage and the Sorted Compare Tool offer this information.
Criteria 5: Minimum investment amount
The next step is to determine whether it’s feasible for you to invest in your shortlist of funds, given how much you can put in and how much you want to be able to take out.
Questions to ask:
What are the minimum initial and ongoing investment amounts? Some funds have a low initial minimum but require a minimum ongoing investment amount or vice versa. Although a fund might have a high minimum amount to invest directly with them, you may be able to access them for smaller investment amounts via platforms such as Sharesies and InvestNow.
What is the minimum withdrawal amount? Many funds have minimum withdrawal amounts, typically the lower of a specified amount (e.g., $1,000) or your investment balance.
When can you withdraw? This determines how long it takes for you to get your money out should you need it.
You can find information on the minimum investment amount on Sorted, and the other information tends to be on the fund’s website (it’s surprisingly hard to find, often buried in a big Product Disclosure Statement - if you can’t find it, contact the fund directly).
A few extra checks
Risk indicator: this is a standardised measure on a scale of 1 to 7, indicating how much the fund’s value is likely to go up and down over time. The higher the risk-return profile of a fund, the higher the rating.
Experience of your fund manager: check how long the fund manager has been in existence and how experienced the key personnel are (how long they’ve been at that specific fund and how long they’ve been in the industry). Also, have a look at the website to see if their general philosophy resonates with you.
Level of service: These are the little extras that a fund manager might offer. For example, some provide regular educational articles or webinars, an app where you can view your investments or helpful support via their phone line.
Final words from Crayon
Doing the due diligence upfront is well worth it. Thank you, Chelsea, for sharing your knowledge with us.
Having said that, don't get stuck in analysis paralysis. Remember: time is your greatest weapon here, so find a fund that is good enough and start investing. And if you find one you like better down the track, you can always withdraw your funds and switch them over.
Investing for the first time can be daunting. If you’ve followed our series from start to finish, you’ve done the hard yards to find a solid investment that will set up your child’s future. And if you need a little extra inspiration, we suggest you read Pene’s first-hand account of how she started investing for her son Hunter. Good luck!
This is part of Crayon’s mini-series on investing in shares for your child:
Now for the important legal part: Investing involves risk. You aren’t guaranteed to make money and you might lose the money you start with. The information we provide is general and not regulated financial advice for the purposes of the Financial Markets Conduct Act 2013. Please seek independent legal, financial, tax or other advice in considering whether the content in this article is appropriate for your goals, situation or needs. The information in this article is current as at 21 October 2022.
All our content is independent. Crayon exists to provide you with accurate and valuable information you can use to make smart money moves for your family. We work with people we respect, and all collaborations are unpaid.
Chelsea Traver
Founder and Investment Adviser Evergreen Advice
Stephanie Pow
Founder and CEO, Crayon
