In a mutual fund, money gathered from numerous individuals is pooled together to invest in a variety of securities, such as bonds, equities, and/or money market investments.
- What is meant by mutual funds?
- What are the 4 types of mutual funds?
- Which is best mutual fund?
- Is mutual fund a good investment?
- How do beginners invest?
Mutual funds are professionally managed by Fund Managers, who allocate the fund’s assets and attempt to produce returns for investors.
What are the benefits of a mutual fund?
You may be a beginner and want to know why mutual funds are a good fit for your investment needs. Perhaps you are a senior investor and need to remind yourself why mutual funds are the best fit for your financial goals and lifestyle. Anyway, here are some of the many advantages you need to know about.
1. Simple: Mutual Funds Are Easy to Understand
Because they are easy, you can invest and succeed with mutual funds, no matter your skill level. They require no background in economics, financial statements, or financial markets.
For beginners, here is a simple definition of mutual fund: A mutual fund is a security type that lets investors pool their money into one professionally managed investment. Mutual funds can invest in stocks, bonds, cash and/or other assets. These underlying security types are called holdings. They combine to form one mutual fund, also called a portfolio.1
Think of mutual funds as baskets of investments. Each basket holds dozens or hundreds of security types, such as stocks or bonds. When you buy a mutual fund, you buy a basket of investment securities.
There are many things to know about mutual funds, but compared to the broad world of financial products, mutual funds are quite easy to use and understand.
2. Accessible: Mutual Funds Are Easy to Buy
You can buy mutual funds from brokerage firms, online discount brokers, mutual fund companies, banks, and insurance firms. Even novice investors can easily open an account in minutes at a no-load mutual fund company, such as Vanguard Investments.2
3. Diversified: Mutual Funds Have Broad Market Exposure
One mutual fund can invest in dozens, hundreds, or even thousands of investment securities. This means you can diversify by investing in just one fund. However, it is smart to diversify into several different mutual funds.1
4. Varied: Mutual Funds Offer Many Categories and Types
As you grow your portfolio of mutual funds, you will want to diversify into varied mutual fund categories and types. You can invest in mutual funds that cover the main asset classes (stocks, bonds, cash) and various sub-categories. You can also venture into specialized areas, such as sector funds or precious metals funds.
5. Affordable: Mutual Funds Have Low Minimums
Most mutual funds have minimum initial investment limits of $3,000 or less. In many cases, if the investor chooses a systematic investment program, the initial needed may be much lower. Some minimums can be as low as $100. Further investments may be lower than $100. If you invest through a 401(k) plan or other employer-sponsored retirement plan, there is no minimum to start.1
6. Low Expense: Mutual Funds Can Cost Less to Manage Than Other Portfolio Types
Costs as a percentage of assets in the portfolio may be lower for an actively managed mutual fund when compared to an actively managed portfolio of individual securities. When you add up transaction costs, annual fees paid to a brokerage firm, and the cost for research tools or investment advice, mutual funds are often cheaper than the typical portfolio of stocks.
How do mutual fund distributions work?
Dividends may take the form of capital gains, interest income, foreign source income, or “taxable dividends.”
Because mutual funds invest in a variety of assets, they can earn income from dividends on stocks and interest on bonds within the fund’s portfolio. The fund typically pays owners a portion of the income received during the year. Even if a fund sells a security that has appreciated in value, most funds pass that profit on to investors in the form of distributions.
Ultimately, if the fund’s net asset value (NAV) increases, but the fund manager does not sell, the price of the fund’s shares will increase. Investors can sell shares in Mutual His Fund on the market to make a profit.
Distributions are generally taxable to the investor whether the distributions are paid out in cash or reinvested into the mutual fund.
How are distributions calculated?
Distributions are allocated to unitholders in proportion to the number of units they hold on a specific date, known as the “record date”.
The frequency at which distributions will be paid will vary depending on the specific fund however can be paid monthly, quarterly, or annually.
Mutual Fund Costs and Expenses
Costs and expenses are the expenses associated with running a mutual fund. Costs and expenses are among the principal criteria for judging the investment quality of a mutual fund. Funds that are passively managed tend to have lower costs and expenses compared with their actively managed counterparts. The “expense factor” is a key determinant of a fund’s investment return to shareholders.
Management Expense Ratio
Understanding Costs and Expenses
As with any business, it costs money to run a mutual fund. There are certain costs associated with an investor’s transactions, such as buying, selling, or exchanging mutual fund shares. These costs are commonly known as “shareholder fees.” There are also ongoing fund operating costs, and “investment advisory fees” are charged to cover the cost of managing the fund’s holdings, marketing, distribution, custodial, transfer agency, legal, accounting, and other administrative expenses.1
Some funds may cover the costs associated with your transactions and your account by imposing fees and charges directly at the time of a transaction. In addition, funds typically pay their regular and recurring fund-wide operating expenses out of fund assets. Because these expenses are paid out of fund assets, they are paid indirectly by the fund’s shareholders.
The fund’s board of directors is responsible for overseeing the fund’s operations and management. The fund’s directors function as watchdogs and should protect the interests of the fund’s shareholders and keep costs and expenses to a minimum. One of the most significant responsibilities of a fund’s board of directors is negotiating and reviewing the advisory contract between the fund and the investment adviser to the fund, including fees and expense ratios. The expense ratio measures how much of a fund’s assets are used for administrative and operating expenses.
The Impact of Costs and Expenses
Costs and expenses vary from fund to fund. A fund with high costs must perform better than a low-cost fund to generate the same returns. Even small differences in fees from one fund to another can add up to substantial differences in investment returns over time.
The more you pay in fees and expenses, the less money you will have in your investment portfolio. And these fees and expenses really add up over time.
Types of Costs and Expenses
Shareholder Fees
The following fees may appear as shareholder fees:
- Sales loads
- A sales charge on purchases
- Deferred sales charge
- Redemption fee
- Exchange fee
- Account fee
- Purchase fee
Annual Fund Operating Expenses
The following may appear as annual fund operating expenses:
- Management fees
- Distribution (and/or service) 12b-1 fees
Other Expenses
The following may appear as other expenses:
- Total annual operating expenses (or the fund’s expense ratio)
Why do MERs vary?
MERs may vary depending on the type of fund and how actively managed it is. For example, index funds generally have lower MERs because they are passively managed in that the fund manager simply matches a market index.
With actively managed funds, however, the fund manager buys and sells securities, seeking to outperform the index. Backed by a team of researchers and analysts, fund managers stay on top of market opportunities, looking for ways to maximize returns while mitigating risk and making investment decisions to pursue the investment objective of the fund.
For the most part, actively managed funds cost more than those that are passively managed because you’re paying for investment-picking expertise.
Mutual funds vs. ETFs
What is an ETF?
Exchange-Traded Funds (ETFs) are investments that seek to combine the diversification of mutual funds with the trading flexibility of securities.
Like mutual funds, ETFs invest in a basket (i.e. portfolio) of securities such as stocks, fixed income or commodities. But, unlike mutual funds, ETFs are bought and sold on a stock exchange. This means their pricing changes throughout the day.
In contrast, mutual fund prices are determined daily after the close of the stock market. Additionally, mutual fund purchases and sales are processed by the fund company.
What are the costs associated with an ETF?
Costs of owning ETFs include management fees, operational expenses and trading fees.
Like mutual funds, ETFs charge a management fee and have certain operating costs for the ongoing operation and administration of the ETF which may be included in the MER. Also, buying and selling ETFs on a stock exchange can incur brokerage fees/commissions.
Investors should review the ETF Facts for more information.
How do the costs of mutual funds and ETFs compare?
Cost-sensitive investors may be interested in the potentially lower annual fees and no investment minimums offered by ETFs, which are typically passively managed. However, if you wish to invest small amounts of money regularly (such as with a dollar-cost averaging strategy or pre-authorized contributions), frequent trading commissions can reduce your returns, increasing the cost of your ETF investment.
Compared to ETFs, mutual funds typically come with minimum investment and higher expenses, such as management and operational fees. However, it’s important to remember that with those higher fees, investors also receive active management which includes the services of a manager who is much more involved in the funds’ investment selection and management and the fees also contain the cost of financial advice.
If you can’t decide between mutual funds and ETFs based on their investment cost, consider what kind of investor you are.
Active vs. passively managed funds
With actively managed ETFs, the Portfolio Manager buys and sells securities based on their research and strategies making tactical and strategic asset allocation decisions regarding the mix of equities, fixed income, etc. depending on the fund’s mandate. They seek to own a basket of securities that is different from an index in an attempt to outperform it to meet a specific objective such as growth, protecting capital or providing income. Active management tends to come at a higher cost given the Portfolio Manager’s skill, research and decision making.
For passively managed ETFs, the Portfolio Manager constructs a portfolio that closely replicates a benchmark index. For example, the ETF would seek to hold a similar basket of securities as the S&P/ TSX Composite Index or the Dow Jones Industrial Average Index. Passive management tends to come at a lower cost since less research and skill are required to achieve index replication.
Which approach best suits your needs?
Active management may be better suited for investors who:
- Seek the potential for better returns with less risk than a benchmark index
- Have a specific objective, such as capital preservation
- Want to take advantage of potential market opportunities as they arise
- Want access to a wider variety of investment strategies, such as defensive strategies aimed at reducing portfolio volatility and risk
- Want a team of experienced professionals to manage investments on their behalf
Passive management may be better suited for investors who:
- Do-it-yourself investors
- Are looking for low-cost exposure to specific investment markets
- Are comfortable with the associated market risk
- Are satisfied to achieve returns that closely mirror a particular index, less the MER