This article is part of Morningstar.co.uk's Equity Investing Week.
You may feel intimidated by the task of picking a fund. With more than 15,000 funds to choose from, it's tempting to buy a magazine or visit a website that will tell you exactly which funds you should buy, or to just pick the fund that's topping the performance charts.
However, these aren't the best ways to find the fund that will meet your goals or suit your investment personality. To give you a better idea of how to approach the vast marketplace for funds, consider these five questions that you need to ask and have answered before buying any equity-focused fund.
1. How has it performed?
2. How risky has it been?
3. What does it own?
4. Who runs it?
5. What does it cost?
These questions form the foundation of Morningstar's approach to fund selection.
How has it performed?
Many people might assume that a fund that produced returns of 22% per year for the past five years has a better manager than a fund that returned 20% per year over the same period. That's sometimes the case but not always. The fund that gained 20% may have beaten competing funds that follow the same investment style by six percentage points, while the 22% gainer may have lagged its competitors by a mile.
To really know how well a fund is doing, put a fund's returns into context. Compare the fund's returns to appropriate benchmarks—to indices and to other funds that invest in the same types of securities.
How risky has it been?
The very act of investing involves an element of risk. After all, you're choosing to give your money to a portfolio manager rather than socking it away under the bed or putting it into a savings account at your local bank.
It's generally understood that the greater the return of an investment, the greater the risk—and therefore the greater potential for loss. Investors who take on a lot of risk expect a greater return from their investments, but they don't always get it. Other investors are willing to give up the potential for large gains in return for a more probable return. Consider a fund's volatility and risk in conjunction with the returns it produces. Two funds with equal returns might not be equally attractive investments; one could be far more volatile than the other.
There are a number of ways to measure how volatile a fund is. There are certain risk measurements that appear in fund shareholder reports, in the financial media, and on the Morningstar.co.uk. These include standard deviation, beta, and Morningstar risk ratings. It's also helpful to check out a fund's quarterly and annual returns in different market conditions to get a sense for its potential volatility.
What does it own?
To set realistic expectations for what a fund can do for you, it's important to know what kinds of securities a fund's manager buys: Stocks? Bonds? Both? These broad asset classes have different characteristics, so you shouldn't expect them to perform in a similar manner. For example, most investors wouldn't expect a 10% gain from a typical bond fund, but that kind of return isn't an unrealistic expectation for certain stock funds.
Unfortunately, a fund's name doesn't necessarily give you a clear idea of the types of securities its manager buys.
As we mentioned earlier, fund managers can buy just stocks, just bonds, or a combination of the two. They can stick with UK companies or invest abroad. They can hold popular big companies, such as 
BP (BP.) or Vodafone (VOD), or focus on small companies most of us have never heard of. They can load up on high-priced companies that are growing quickly, or they can favour value stocks with lower earnings prospects but cheap prices. Finally, managers can own 20 or 200+ stocks. How a manager chooses to invest your money is one of the most important factors that will drive performance.
To get a feel for how a manager invests, examine a fund's portfolio. The financial statements published by the fund company always disclose this information and Morningstar's Portfolio tab on a Funds Report breaks down the fund's portfolio by style, asset, region, and sector so you can see the manager's investment style at a glance.
Who runs it?
Funds are only as good as the people behind them. The fund managers who make the investment decisions are the main people responsible for a fund's performance. Therefore, it's important to know who calls the shots at your fund—as well as how long he or she has been in charge. Make sure that the manager who built the majority of the fund's record is still the one in charge. Otherwise, you may be in for an unpleasant surprise.
What does it cost?
Funds aren't free. You should pay for professional money management if you need it, but paying enormous expenses to invest is essentially giving money away. That's because every penny that you give to fund management or to brokerage commissions is a penny you take away from your own return. Furthermore, costs are one of the few constants in investing: They'll remain pretty stable year in and year out while the returns of stocks and bonds will fluctuate. You can't control the whims of the market, but you can control how much you pay for your funds.
Morningstar provides a breakdown of a fund's costs in the Fees section of its Fund Report on Morningstar.co.uk. You can also find more information in this section about the minimum investment you'll need to make into a particular fund. Morningstar will also tell you whether you can put this fund into your ISA, which is useful for tax purposes.
The original version of this article was published December 2009.
