A Mutual Fund is a pool of investments that is owned by many people and managed by professional portfolio managers. Investors own part of these pools, also known as investment funds, by buying shares or units of the fund. The money from the purchase of units is invested by professional fund managers in a variety of assets with the expectation of increasing the value of the fund.
Mutual Funds became very popular before the advent of discount brokerages because they allowed investors to build a diversified portfolio without incurring the cost or the work to build that portfolio from individual assets. These days, there are mutual funds for almost all asset types, the most popular being stocks and bonds, and you can generally buy a mutual fund to cover any type of asset. For example, you can buy mutual funds that only hold stocks from small companies (small cap stocks), or companies from Asia, or focused on the manufacturing sector, or have high dividends. You can even buy mutual funds that focus on multiple factors – such as large cap companies in the oil & gas sector in Europe. ]
The fees associated with a mutual fund pay the cost of the fund managers, the transaction costs to buy and sell the assets and of course the profit for the owners of the fund. Fees can be front loaded commissions, back loaded commissions or no commission (no load). But even if there are no commissions to be paid, you will pay an annual management fee to the mutual fund that can vary anywhere from .5% to 2% and more depending on the types of assets held. Most discount brokerages have a screening tool to help you select mutual funds and your Financial Advisor can also help.
Most Canadian funds belong to one of two groups: open or closed-end. The vast majority of mutual funds are open-end.
Open-end funds are like their closed-end brethren in one respect: they allow an investor to own a piece of diversified portfolio of securities managed on a full time basis by professional investment managers. There is no limit to the number of shares available.
Closed-end funds unlike open-end funds have a fixed number of shares which are generally traded like shares on stock exchanges.
Types of Mutual Funds
Mutual funds come in a variety of types, each with its own investment objectives. Depending on the mandate, there are different risks and different rewards.
Money Market Funds
The objective of this type of fund is to provide a high level of income and liquidity through investment in short-term money market instruments such as treasure bills, commercial paper, and short-term government bonds.
Goals are income and safety. Not as risky as bond funds because mortgage terms are usually relatively short ( 5 years or less).
Income and safety of principal are the main objectives. However, investors should recognize that they will be subject to capital gains and losses, depending on interest rate movements.
Has a goal of tax-advantaged income with some possibility of capital appreciation. These funds invest in preferred shares and high quality common shares that consistently pay dividends. The income from these funds qualifies for the dividend tax credit, an advantage to investors.
These funds provide investors with a mixture of safety, income and capital appreciation.
The primary objective of equity funds is capital growth, although dividends may contribute to the total return.
Specialty Equity Funds
Some investors like to diversify into specialty areas that they feel will have the potential to outperform the overall markets. These types of funds invest in specialized markets or industries, such as natural resources, real estate, science & technology, which, although subject to volatility, may provide increasing opportunities for growth over the long term.
As more and more investors are realizing that the best investment opportunities often lie outside of Canada, international funds are gaining in popularity. These types of funds allow investors to access stocks on a worldwide, regional and/or even country basis.