Many Canadians include mutual funds in their investment portfolio. There are different kinds of mutual funds to choose from. They vary by management style and risk profile. If you decide to invest in mutual funds, it’s important to look for a good fit for your investing goals. Learn more about buying and selling mutual funds.
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What is a mutual fund?
A mutual fund is a collection of investments, such as stocks, bonds and other funds owned by a group of investors and managed by a professional money manager. The investment objective of the mutual fund determines what types of securities it buys. A mutual fund can focus on specific types of investments or a variety of investments.
When you buy a mutual fund, you’re pooling your money along with other investors. You buy units or shares of the fund. As more people invest, the fund issues new units or shares.
The investments in a mutual fund are managed by a portfolio manager. They manage the mutual fund on a day-to-day basis, deciding when to buy and sell investments according to the investment objectives and strategies of the mutual fund.
There are two ways your mutual fund investment can grow over time:
- Capital gains – If you sell your mutual fund for more than you paid for it, you will have a capital gain. If you sell your mutual fund for less than you paid for it, you will have a capital loss.
- Distributions – Depending on the type of mutual fund you buy, you may also receive distributions of dividends, interest, capital gains or other income the fund earns on its investments. You can choose to receive distributions in cash or have them reinvested in the mutual fund for you. Unless you ask for the distributions to be paid in cash, the mutual fund will usually reinvest the distributions for you.
When you purchase, switch or redeem securities of a mutual fund, you pay or receive an amount that is represented by what is known as the net asset value (NAV) of the security at the time of purchase, switch or redemption. Most mutual funds report their NAV daily in the business section of many newspapers, or on the fund manager’s website. NAV represents the mutual fund’s assets less its liabilities. NAV will fluctuate with changes in the market value of the mutual fund’s particular investments. The NAV is generally calculated only once every business day. This is different from buying individual stocks, whose prices may fluctuate throughout the day.
What are the common types of mutual funds?
There are several types of mutual funds, including:
- Money market funds – Invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. Money market funds are generally a safer investment, but with a lower potential return then other types of mutual funds. Canadian money market funds try to keep their NAV stable at $10 per security.
- Fixed income funds – Buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. Fixed income funds aim to have money coming into the mutual fund on a regular basis, mostly through interest that the mutual fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds.
- Equity funds – Invest in stocks. Equity funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.
- Balanced funds – Invest in a mix of equities and fixed income securities. Balanced funds try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer fixed income securities such as bonds, while conservative funds hold fewer equities relative to bonds. Learn more about diversifying by asset class.
- Index funds – Aim to track the performance of a specific index such as the S&P/TSX Composite Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.
- Specialty funds – Focus on specialized mandates such as real estate, commodities or ESG investing. For example, an environmentally oriented fund may invest in companies that support low-carbon or carbon-neutral economic growth and avoid investment in fossil fuels.
- Fund-of-funds – Invest in other funds. Similar to balanced funds, fund-of-funds try to make asset allocation and diversification easier for the investor. The management expense ratio (MER) for fund-of-funds tend to be higher than stand-alone mutual funds.
One way to better understand whether a mutual fund is right for you is to read disclosure documents such as its Fund Facts document or recent management reports of fund performance. These documents are available from your advisor and the mutual fund company’s website. Mutual fund companies are required to give investors a copy of Fund Facts before they decide to purchase a conventional mutual fund.
How do you buy a mutual fund?
As with most investments, there are a few key steps to buying a mutual fund:
- Decide how much to invest, and for how long – Before buying any investment, consider how it fits into your investing goals, and how long you want to invest for. Knowing your goals helps narrow your time horizon, and your tolerance for risk.
- Choose what type of fund –Your risk tolerance will help you decide the type of fund you want to invest in, as each fund will match a specific kind of risk profile. For example, a fixed income fund that pays a fixed rate of return will have lower risk. But a fund weighted towards more equity – or investment in stocks – will have a higher degree of risk. And if you’re trying to balance risk and return more moderately, consider a balanced fund.
- Consider the fund’s fees –Like many investments, mutual funds carry fees. The fund’s management fee and operating expenses make up a fund’s MER. Fees can reduce your rate of return over time. Be sure to review what fees you pay directly, such as sales charges, and what fees the mutual fund pays, such as management fees and operating expenses.
- Compare the MERs and performance of similar funds – While past performance doesn’t necessarily predict the future, knowing how a fund has performed in the past can give you an idea of how a fund performed in certain market conditions. Use this mutual fund fee calculator to see how fees and other costs can affect your investments.
- Choose a financial advisor or mutual fund company – Be sure to buy only from registered firms and individuals. Anyone selling or providing advice about mutual funds must be registered with their provincial securities regulator. In Ontario, this is the Ontario Securities Commission. Also learn how your advisor will be compensated for selling you a mutual fund. Find out if they focus on the funds of a certain mutual fund company or a certain family of funds.
- Complete the application and buy the funds – As part of the process when buying a mutual fund, you may be asked personal information such as how much risk you are willing to take, and how much you know about investing. Be prepared with this information when buying any new investment.
In general, you can cancel your order to buy a mutual fund within 48 hours after you receive confirmation of your order. Rules vary in some provinces.
How do you sell a mutual fund?
When you’re ready to sell your mutual funds or a portion of them, there are a few key steps:
1. Contact your financial advisor or mutual fund company
Get in touch with the advisor who sold you the fund, or someone in their company. If you bought directly from the mutual fund company, contact them directly.
2. Ask about any fees or charges
You may pay fees to sell your mutual fund units or shares. Find out how much before you decide to sell. The size of the sales charge depends in part on how long you have held the fund, and the company you’re dealing with.
3. Decide how many units or shares you want to sell
If you’re selling your mutual funds for a specific reason, you may be expecting to sell for a certain amount. Since the price of most mutual funds is calculated at the end of each business day, you may need to consider that day’s price as an estimate.
You may have to sign a form stating that you want to sell your units or shares. This stops anyone from selling them when you don’t want them to.
4. Give instructions on what to do with the money
You can have the advisor or company:
- Send you a cheque.
- Deposit the money in your bank account.
- Use it to buy other mutual funds or investments.
If you want to move your money to another fund at the same mutual fund company, you can usually do a simple exchange. This may save you some time and money.
You may owe tax on earnings from your mutual funds and other investments, depending on the type of account you hold them in. Learn more about making money from investing and how your earnings may be taxed.
Learn more about how tax affects your investments.
How are mutual funds managed?
Mutual funds are managed by a professional money manager. Portfolio managers may have different investment philosophies or use different styles of investing to meet the investment objectives of a fund. This can allow you to diversify your investments within the mutual fund. It can be another way to reduce investment risk.
There are different strategies a portfolio manager may use for managing the investments of a mutual fund, including:
- Top-down approach – Looks at the big economic picture. Finds industries or countries that look like they are going to do well and then invests in specific companies within the chosen industry or country.
- Bottom-up approach – Focuses on selecting specific companies that are doing well, no matter what the prospects are for their industry or the economy.
- A combination of top-down and bottom-up approaches – A portfolio manager managing a global portfolio can decide which countries to favour based on a top-down analysis but build the portfolio of stocks within each country based on a bottom-up analysis.
- Technical analysis – Attempts to forecast the direction of investment prices by studying past market data.
- Active management – The portfolio manager buys and sells investments, attempting to outperform the return of the overall market or another identified benchmark.
- Passive management – Involves buying a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.
Learn more about how mutual funds work. You may also want to speak with a financial advisor to help you decide which types of funds best meet your needs.
Summary
There are different types of mutual funds, each with different management approaches and overall risk profiles. If mutual funds make sense for your investing goals, consider these key points:
- As with any investment, consider how much you want to invest and for how long.
- Know your level of risk tolerance so that your mutual fund is a good match.
- You can buy mutual funds from a financial advisor or from a mutual fund dealer directly.
- Ask about any fees or charges and review the Fund Facts documents before buying.
- When you’re ready to sell your mutual fund, make sure you know how much you want to sell, and what you’d like to do with the money.
