A fund of funds is a type of mutual fund that is made up of other mutual funds (and occasionally ETF’s). Similar to a book that is a collection of poems. You get a bunch of different poems in one book.
These funds were designed to make investing easier by placing all of your allocations in one fund. Hypothetically you could have only one fund, instead of multiple funds. You put your money in and the managers take care of the rest.
There are three main types of fund of funds:
If you are in doubt if a fund is a balanced fund or an asset allocation fund, you should read the prospectus to understand what extremes the managers are allowed to go. All funds are required to have specific limits and guidelines on where they are investing. You will see exactly what the minimum and maximum percentages are in each asset category.
First you want to make sure that the level of risk that the fund is taking is what you find acceptable. (Not sure what your asset allocation should be? Here is my favorite chart to help you decide.) To do this you can do this one of two ways:
Remember, even if the guidelines are in line for everything that is recommended if you are uncomfortable with the investments then you should not invest in them. You still need to sleep at night. You can build a more conservative portfolio using individual funds. Just remember you may need to save more to get to where you want to be by taking less risk.
This step you can continue to use one of the two resources from the above section. You will want to look up not only the funds cost, but also the cost on the underlying funds.
On the funds website the information on the cost of the fund should be on the summary page. Then to get the cost of the underlying funds you need to head to the portfolio information and take a look at each of those funds. Once you have those you can search for each of those funds on the site and go to its summary page to get the expense ratio.
On Morningstar it is a bit easier, on the portfolio page at the top click on Holdings and then scroll to the bottom. Here you will see a list of funds, you can actually click on the fund and it will open a new tab for that fund, from here you can click on quote and see the fees!
While determining the exact amount of fees that is acceptable can be difficult, I would recommend you try and stay under 1.25% and preferably under 1%. I did write a post on fees if you need more information. The Impact of Fees on Mutual Funds
This is probably the hardest thing to measure, as many fund companies have fantastic funds and also some bad funds.
Other than going fund by fund, I recommend heading to Morningstar and using their Fund Family pages. Now, these are not overly easy to find, but head to the bottom of the page, select the Site map and then under Mutual Fund Performance data you can select the fund company you are looking at. Once you click on that fund you can do a quick scan of the fund companies funds, rating and returns. If you click on the words Data Pages next to the name, it will take you to a snap shot page that includes averages for expenses, returns and lots of great information.
By scanning this information you should be able to determine if across the board fees are reasonable and how many funds are on the bad side that you may be invested into.
Finally assuming that the risk levels are acceptable, the fees are good and you are happy with the fund company. You need to decide if you would rather set it and forget it with a fund of funds, or if you would once a year rebalance your portfolio and adjust your allocations they vary and the market changes. If you can pretty much guarantee that you won’t touch it after you set it then one of the fund of funds is probably the best way for you to go. If you will sit down once a year and make sure you are on track, then you may be better off picking individual funds as you will pay less in fees and you have more control over what you are invested in.
Ultimately it is a decision that can only be made by you. You need to look at all the information, pair that with your personality and habits to create a winning investment plan for you. Happy Investing!