Mutual funds 101


Mutual funds 101

What is a mutual fund?

A mutual fund is an investment portfolio made up of diversified securities, such as stocks, ETFs, bonds, and other money-market instruments. It is managed by professional advisors who aim to fulfill the objectives outlined in a particular mutual fund’s prospectus. Mutual funds pool the capital of multiple small investors who then collectively share the impact of the fund’s performance.

Why invest in mutual funds?

Mutual funds are a popular investment product in Canada. They present everyday investors with an opportunity for diversification at an affordable price. If you opt for investments in a range of sectors and assets, such as in a mutual fund, you avoid reliance on one security and minimize your vulnerability to the market itself. In other words, trading mutual funds has the potential to lower your risk.

Mutual funds can also be attractive because they place fewer burdens on investors themselves. They are professionally managed by investment advisors. As a result, investors do not have to actively monitor their funds as closely as they would individual securities..

Mutual funds are also extremely accessible. Most banks and brokerages offer an extensive line of funds, and minimum investment costs are typically set at attractive rates. However, they are often less liquid than other types of securities although most can be redeemed within one to three business days.

How do I buy and sell mutual funds?

Mutual funds can be purchased directly from the fund itself or from a broker, bank, financial planner, or insurance agent, and they can be bought and sold on a continuous basis. When you buy funds through a third-party, your costs will often be joined by a transaction fee.

Before you buy any mutual funds, however, you should conduct research to identify whether or not a mutual fund’s strategy and risks will be compatible with your own risk level and investment objectives. Review the prospectus and profile (if applicable) to obtain more information about the mutual fund’s past performance, goals, principle strategies, risks, and fees.

What is NAV?

NAV, or net asset value, is the value of the mutual fund. The NAV per unit is the price of one unit of a mutual fund, and it fluctuates on a daily basis. When you purchase units in a mutual fund, you pay the current NAV per unit plus any applicable loads.

What are the associated fees?

There are a number of fees associated with mutual funds. These fees must be taken into consideration when calculating your potential returns. Some investors may view these fees as hidden fees because they are deducted directly from the fund’s overall assets Remember, higher expenses are not an indicator of a mutual fund’s expected success or failure.

In general, fees will belong to one of two categories: ongoing fees or loads.

Ongoing fees

Ongoing fees are expenses that are directly tied to your continued investment in a fund. These fees fall under the management expense ratio (MER). They will either go toward the operation and administration of your fund or directly to your fund manager in the form of a management fee. Management fees are compulsory payments regardless of management or fund performance. It is possible to avoid a portion of these costs if you align yourself with a bank or brokerage firm that offers rebates.
Select funds will also have an additional 12B-1 fee, or distribution fee, which is primarily imposed to help finance the advertisement and promotion of the fund.

Loads

Loads are transaction fees paid to the representative, the broker or salesperson, that executes the buy or sell of your funds. Loads are additional costs. Expensive loads are not to be regarded as a positive measure of a mutual fund’s performance.
There are two types of loads. Front-end loads are up-front sales commissions that are paid at the time of a fund’s initial purchase. Back-end loads are implicitly tied to your mutual fund, but will only be applicable if you sell it within a pre-determined timeframe. The cost of the back-end load will decrease the longer you maintain your units.

What are mutual fund classes?

Funds that belong to different classes will be subject to different fees and unit holder services. The different classes will, however, invest in the same portfolio. Depending on whom you execute your mutual fund trades with, the number of classes will vary. Class A, class B, and class C are typically the three main classes
These classes can be distinguished by their associated loads. Class A units have a front-end load, and class B units have a back-end load. Class C units will have either a front-end or back-end load, but it will be lower than that of class A or B units.

Which fund is right for me?

From a fundamental and high-level overview, there are three main genres of funds. The type of fund you choose will depend on your own investment objectives.

Money market funds

Money market funds are a conservative investment that offers little risk. However, it also yields small returns. It is common for investors to use money market funds as an alternative to a chequing or savings account, which typically has returns two times lower than that of a money market fund. Money market funds offer short term income and stability. The NAV per unit is typically maintained at one dollar.

Bond funds

Bond funds present higher risks than money market funds although they are also a popular option for retirement savings. They are typically invested in government and corporate debt. Unlike money market funds, they are accompanied by interest rate risks. If the rate increases, the value of the fund declines. Bond funds are also referred to as fixed-income or income funds because their primary objective is to provide investors with a steady income.

Equity funds

Equity, or stock, funds are the most likely to produce long-term capital gains. Invest in equity funds if you have a high risk tolerance because they have the greatest short-term market volatility. However, equity funds also have the greatest potential for high returns. They also offer the most expansive selection of mutual funds.

If you are interested in both bond and equity funds, you may choose to opt for a balanced fund, which invests in both.