Posted: May 06, 2020 by Sean Cooper in Invest, Money tips
Finance basics: Get to know mutual funds
If you’re like most Canadians, you’ve probably heard a lot of talk about mutual funds and know they’re an important part of most investment plans. But you may not know exactly what they are, how they work or what you can do with them. Don’t worry — we’ll help you find out.
Luckily, it’s easier than you might expect to get a better understanding of mutual funds. With some quick reading, you can learn about the common types available, how you can invest in them and when you should start investing. Let’s get started.
See more from the “Finance Basics Series” including RRSPs and RESPs.
What is a mutual fund?
A mutual fund is a collection of stocks, bonds and other investment types that are professionally selected and managed for you by a “portfolio manager.” As the fund grows, so will your investment, which you can withdraw at a later time — for example, when you want to buy a home or retire.
Mutual funds can be held on their own or in an RRSP, TFSA or RRIF, making them a common option for many Canadians.
Another way to think of mutual funds
Think of mutual funds like a big community garden where you can purchase a little plot of land. By investing in the plot of land, you get seeds (aka your stocks and bonds) and a professional gardener (aka your portfolio manager).
The gardener’s job is to make sure the entire community garden is always watered, the land is fertilized and weeded, and all the crops grow at a nice steady pace. That way, you’ll have some assurance that the whole garden is doing well, and when it comes time to harvest your little plot of land, you’ll have fruits and vegetables ripe for the picking.
Who can own mutual funds?
The short answer is — anyone. Unlike other types of investments, mutual funds aren’t the sole property of one single person. Instead, they are owned by many investors — and if you purchase a mutual fund, you become one of these investors.
As an investor, your money is pooled with all the other investor money to purchase the securities held by the mutual fund. Then, as the mutual fund grows in popularity, new units or shares may be issued to meet investor demand.
Why would I invest in mutual funds?
You can do a lot with your money, but it’s important to diversify your investments since no return is ever a guarantee. Some of your investments will grow faster than others, while other investments could decrease in value during certain periods. The goal of a diversified portfolio is to balance each other out.
By their very essence, mutual funds provide a balanced return. Compared to putting your money into a ‘no risk’ savings account with a lower interest return, mutual funds may provide a higher return over time. On the flip side, higher risk investments can deliver greater returns, but if the market declines, the value may decline as well.
Are there different types of mutual funds?
Yes, and each will have its own focus that will be explained in its overview document, called a “prospectus.” There are thousands of different types of mutual funds, and the focus can be on specific types of investment such as equities, bonds and cash.
At the same time, mutual funds may centre on more than just finances such as a certain country or region of the world. In other cases, mutual funds can focus on the public sector (government), while others focus on the private sector (corporations). More on this coming up…
How do I know which fund to pick?
Your advisor will explain the focus of the fund, so that you feel comfortable that it matches your overall goals, risk tolerance and investment strategy. If you don’t yet have a strategy, they’ll also walk you through different questions to determine how much risk you’re comfortable with, how long you plan on investing, and what you want to achieve in the future.
How do you invest in mutual funds?
Mutual funds can be purchased at a wide variety of places including credit unions, banks, trust companies, life insurance companies, mutual fund dealers and investment firms.
The majority of mutual funds are purchased through financial advisors who work for companies that are registered to sell these types of investments. However, you can also follow a more DIY style approach online through a discount brokerage. Keep in mind that you may not get the personal assistance and financial expertise of an in-person advisor.
Can I still invest responsibly?
Yes, you can invest in mutual funds and still make choices that reflect and support your values. This is part of a socially responsible investing (SRI) strategy, and your advisor can also direct you to these types of funds. Environmental, social and corporate governance (ESG) criteria can be part of your investment choices, including corporate initiatives on climate change, pollution, human rights, gender equality, women in leadership and cybersecurity.
Read: What is Responsible Investing and how can I get started?
Who manages the mutual fund for me?
As mentioned, a mutual fund is professionally managed. Your portfolio manager looks after the investments held inside the mutual fund on a daily basis, making decisions about when to buy, hold and sell based on the fund’s objectives.
What are some examples of mutual funds? How risky are they?
Similar to other investments, mutual funds come in all different shapes and sizes — and their risk level depends on the type of fund. Here are some of the most common ones.
- Money market funds: These are funds that invest in short-term debt, such as government bonds, treasury bills and commercial papers. Money market funds are considered as safe as bank deposits, however, they tend to provide the lowest potential return of mutual funds types.
- Fixed income funds: These funds purchase investments such as government bonds and corporate bonds that pay a fixed rate of return. Fixed income funds mainly earn money though interest, and these are considered safe investments, although slightly more risky than money market funds.
- Equity funds: These funds invest in stocks. As such, their objective is to achieve a higher long-term rate of return than money market and fixed income funds. However, since these funds are investing in riskier investments, they tend to have more volatility. It’s generally wise to only invest in equity funds if you’re investing for the long-term.
- Balanced funds: Instead of just sticking to one investment type like equities or fixed income, balanced funds invest in a variety of investment types. A balanced fund tries to balance the goal of earning a higher rate of return versus the risk of losing money. As such, they tend to be more risky than fixed income funds and less risky than equity funds.
When should I start investing in mutual funds?
The old saying, “It’s never too early…” really applies when answering this question. The sooner you invest, the sooner your money can do more.
Getting started is easy, and you may already have the savings to move forward. Most mutual funds have minimum investment amounts, which can give you a goal to reach when saving up for an investment. Even if you haven’t reached that level quite yet, your advisor can help you establish an easy-to-follow plan to make that happen.
Set up an appointment with an advisor today through our digital appointment tool. Before you know it, you’ll be on the path to a better investment strategy.
Mutual funds are offered through Credential Asset Management Inc. Mutual funds and other securities are offered through Credential Securities, a division of Credential Qtrade Securities Inc. Credential Securities is a registered mark owned by Aviso Wealth Inc.
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