Mutual Fund Featured Image

Know your Financial Lingo- What’s a Mutual Fund?

A Mutual Fund is a type of financial vehicle consisting of a pool of money collected from many investors to invest in a group of securities. Mutual funds are managed by a professional fund manager who allocates the fund’s assets in order to produce a return for investors according to stated objectives. 

When you buy units of a mutual fund, you are pooling your money with other investors. This enables retail investors to diversify and own a much wider mix of investments than you would likely be able to afford on your own. 

What are the types of Mutual Funds?

The three main types are:

1/ An Equity Fund invests primarily in different kinds of stocks

2/  A Fixed Income Fund invests primarily in bonds

3/ An Asset Allocation, or Balanced Fund invests in a mix of both.

person asking what Mutual Fund means, a second person offering to tell them how a mutual fund works

Why would you invest in a Mutual Fund? 

Advanced Portfolio Management 

  • Actively managed mutual funds allow you to take advantage of professional investment management. A fund manager does the research and analysis required to find quality investments to hold in the fund.

Easy Diversification

  • When you invest in a mutual fund, you are investing in a diversified portfolio of investments that can include a varying mixture of stocks, bonds, and cash equivalents, depending on which mutual fund you choose.  A downturn in any given asset class, region, or sector may be balanced by strong performance in another.  

But Mutual funds have downsides:

line chart showing ETF has higher balance over time than mutual funds

A representation (for illustrative purposes) of possible accumulation over a long period of  time of  Index ETFs vs. Mutual Funds incorporating typical performance, MER, and sales commissions

Higher Fees  

  • All mutual funds have fees and administration expenses that go to the fund manager that reduces your investment return. These are expressed as a percentage of the funds under management, called the MER (management expense ratio).  You may also be charged penalties for early redemption or a sales commission that goes to your investment advisor for the purchase. ETF (exchange-traded funds) have become a more popular alternative in recent years for their lower MER charges. 

Capital Gains Taxes

  • One potential downside of mutual funds happens due to rebalancing within the fund. When the fund manager buys or sells an investment that has gone up in value, it triggers capital gains taxes. These expenses are passed on to the investor if you hold the mutual fund outside of an RRSP or a TFSA.

Investing in a mutual fund can be an effective way to save for important goals such as retirement, but should be evaluated versus other alternatives to optimize reaching your financial goals.

WealthyPlanet's "Wealthopedia"  series demystifies financial terms and financial industry lingo. 

 

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