Just as important as finding the best funds is avoiding those that will lose you money.
This has become clearer than ever this month as investors in the £3.7bn Woodford Equity Income fund found themselves trapped when it was announced the fund would suspend trading.
They will have to wait until it reopens to get their money out, a process that could take months.
However, there are lessons to be learned both from those that find themselves stuck and for those that avoided the debacle.
1. Size really can matter
It is important to stress that fund size and liquidity are two very different things. It is perfectly possible for a smaller fund to allocate too much of its capital to illiquid stocks in the same way as Mr Woodford. However, the sheer size of his fund, which peaked at £10.3bn, did not help.
Gill Hutchison of research firm The Adviser Centre, said: “Growing funds do not automatically become bad funds, particularly when the changes occur over a long period of time and they are communicated clearly to investors.”
However, those that grow or fall in size very quickly, like Mr Woodford's, should ring more alarm bells.
Funds that have grown very quickly have often done so through momentum, with investors following the crowd into the next big thing.
Check what these big funds are invested in. For an investment to be worthwhile for funds of this size they will typically run into the tens of millions of pounds. Often this means the fund owns a large proportion of a small company, which can be difficult to sell.
More appropriate assets for larger funds would be highly liquid blue-chip stocks or government bonds.
Victoria Hasler of fund ratings firm Square Mile Investment Consulting & Research said: “The size of the fund should be appropriate to the types of assets in which a manager is investing.”
2. Don’t jump on the hype train
When Mr Woodford left Invesco to set up on his own, there were many that were quick to recommend him.
As his funds got off to a flyer (his was among the best managers for the first one and three-year periods) the hype began to build.
Martin Bamford of financial advice firm Informed Choice, said: “Looking back now at some of the headlines, including one calling him Britain’s answer to Warren Buffett, is frankly quite embarrassing for the investment sector.”
No manager, no matter how skilfull, is immune from periods of poor performance.
This can be magnified by sales promotions, which offers far less protection than regulated financial advice, Mr Bamford said. “With so much of the Woodford money funnelled in from Hargreaves Lansdown, it’s a good reminder that without a specific recommendation to invest in a fund, there is no recourse when things go wrong.”
Ruairi Dennehy, of adviser Dennehy Weller & Co, added: “People do genuinely think they aren’t silly enough to fall into these traps, but I’ve heard hugely successful and wealthy people admit to me they’ve bought an investment because of an advert alone.”
3. Keep checking the fund after you’ve bought it
A Woodford spokesman said the manager has "continued the same valuation-focused investment strategy as he has done over his entire 30-year plus career."
Yet part of the trouble for investors in the fund is that, over time, the style of the fund had changed.
Research firm Morningstar has noticed a drift in style from investing in larger companies to smaller companies.
Part of this will be due to the high redemptions, as larger companies are easier to sell quickly than smaller ones.
But investors not keeping up with the latest changes may have been caught out, particularly if they bought early on and had not look at the investment since.
Peter Sleep of Seven Investment Management, said: “Look at the annual report of the fund from time to time and look at the list of investments.”
Investors should ask themselves if anything looks odd and if the stocks are consistent with the aim of the fund.
4. Be wary of start-ups
Small fund houses, "boutiques" in fund management speak, can seem like a good investment idea as there tend to be fewer bureaucratic distractions so managers can focus on delivering outperformance.
However, Mr Sleep said: "A question that should be asked is whether there is a sufficiently robust framework to allow for the ideas and decisions of the portfolio manager to be challenged internally."
High turnover of staff or the changing of advisers may be signs that something is not quite right, he advised.
Ms Hutchison added: “No matter how talented you think a fund manager is, appropriate resource and controls are of the utmost importance.”
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