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What Is a Fund of Funds?

Dori Zinn

While investing does include stocks and bonds, it also includes many small securities put together. Sometimes portfolios have funds that are pooled, which include stocks, bonds and other securities. That type of investment is called a fund of funds.

Before you invest, learn what a fund of funds is and if it works for your portfolio.

What Is a Fund of Funds?

A fund of funds is a multi-manager investment that contains different types of funds in one. It includes stocks, bonds and other securities. They usually invest in mutual funds or hedge funds to gain instant diversification among many different asset classes. But you might also see FOFs that are private equity funds or an investment trust. One of the most common FOFs is a target-date fund.

Since a fund of funds has a wide variety of diversification, it also has lower risk compared to other types of securities. There are two different types of FOFs: fettered and unfettered.

  • Fettered: This type of FOF invests only in other types of funds offered by the same management company.
    Unfettered: Can freely mix funds from many different investment companies to build a portfolio.

Fund of Funds: The Pros

Before investing in a fund of funds, make sure you know how they are working for you. There are a few good things about having FOFs, including:

  • Instant diversification: Since your fund is comprised of more than just one type of security, you get access to instant diversification. Your investment is spread across many different types of securities.
  • Minimal risk: Mutual funds — one of the main types of funds that FOFs invest in — don’t carry as much risk as other types of investments, like stocks.
  • Professional management: Not every investment type gives you the chance to have professional wealth management services geared towards your investment goals, but FOFs do. You’ll be able to benefit from specific, tailored management and advice based on the type of investor you are and your fund goals.

Fund of Funds: The Cons

While there are some good qualities of FOFs, there are some drawbacks, including:

  • Higher fees: With the professional management services you’ll receive, you can also expect to pay higher fees and expense ratios compared to other mutual funds. The extra expense could cancel out any benefit of FOFs.
  • Limited managers and funds: Not all fund managers operate FOFs the same way. It might be more difficult to find a qualified professional to handle those investments for you.
  • Less long-term growth: While minimum risk is a good thing, it also brings in less reward compared to other investments. FOFs often earn less than their index fund siblings in the long run.

Alternatives to a Fund of Funds

If you want the instant diversification that FOFs bring but are hesitant to invest due to the higher fees, you might want to look elsewhere. FOFs aren’t the only funds to choose from. Luckily, there are other types of investments, like:

  • Mutual funds: Rather than invest in FOFs that invest in other mutual funds, go straight for the mutual funds themselves. You’ll get the professional-grade management, but you’re not limited to fettered and unfettered restrictions. Keep in mind that fees for mutual funds might be higher than ETFs and index funds since they are usually actively managed.
  • Exchange-traded funds: ETFs are a type of security that invests in an underlying benchmark index. While similar to mutual funds, they trade more like individual stocks since they’re on an exchange. They usually have lower expense ratios and fewer fees compared to mutual funds.
  • Index funds: Index funds are a type of mutual fund that tracks a market index. It’s passively managed, which means it’s more hands-off for you as an investor. They charge lower fees than other types of funds and are usually a great starting point for new investors or those looking for hands-off or passive investing. It’s the go-to for most robo-advisors.

Bottom Line

Investing in a fund of funds has its advantages. Notably, having professional management services can give you an edge compared to a passive robo-advisor. But it’s limited in how it operates and who manages it. An FOF could end up owning the same stock or security through multiple funds. This means you don’t have as much diversification as you would’ve expected with a regular mutual fund or another type of fund.

Tips For Investing

  • Consider talking to a financial advisor about whether a fund of funds is a good idea for your portfolio. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • If you’re not sure you need much help with your investments, or you have a little extra cash on hand, you might not need as much professional management as others. Using a robo-advisor is a great introduction to investing without the added fees of a manager — or team of managers — handling your account. Robo-advisors are passive and usually work well for most people. But keep in mind that not everyone has the same financial situation, income or retirement plans, which means what works for most people might not work for you.

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