Fusion Credit Union - How To Grow Your RRSP

Intro to Mutual Funds

What are mutual funds?

A mutual fund is a collection of investments owned by a group of investors and managed by a professional. The investments included within a specific mutual fund are determined by its objectives, and can include stocks, bonds and other fixed income securities, or a mix of both.

A mutual fund is managed by a portfolio manager who decides what investments to buy and sell, and manages the fund based on its investment objectives. You, the investor, don’t make any decisions about a mutual fund’s underlying securities. Instead, the portfolio manager decides what and when to buy and sell the mutual fund’s securities according to the mutual fund’s objectives.

Types of mutual fund

There are many types of mutual funds available, each one designed with a mix of investments to suit different investment goals and objectives as well as risk levels. Most funds focus on specific asset types, but others have specialized mandates for investment in a specific sector, geographical region, group of commodities, or thematic mandate such as socially responsible investing.

The main types of mutual funds are:

Money market funds – focused on short-term fixed income, including government bonds, treasury bills, bankers’ acceptances, etc. Also viewed as “cash equivalents”, a money market fund is generally a safer investment, but with a lower return potential than other types of funds.

Fixed income funds – focused on government bonds and investment-grade and high-yield corporate bonds. These funds usually aim for a regular stream of income, and because of their corporate bond holdings (particularly in the high-yield category), carry more risk than funds that only hold government bonds.

Equity funds – focused on stocks, these mutual funds generally aim for growth rather than a steady income stream. Equity funds carry greater risk than money market and fixed income funds.

Balanced funds – focused on a mix of equities and fixed income securities, these funds aim for a balance between income and the higher risk of stocks. Balanced funds carry more risk than fixed income funds, but lower risk than an equity fund.

Index funds – focused on tracking the performance of a specific index, the performance of these funds fluctuate with index they track (such as the S&P/TSX Composite Index or the S&P 500 Index). Because a portfolio manager has fewer investment choices decisions to make in an index fund (because they are “passively” managed), they typically come with lower fees than an “actively” managed fund.

Fund of funds – focused on investment in multiple mutual funds, these funds allow for easier asset allocation for an investor. The fees to buy and sell these funds is generally higher than other funds.

How are mutual funds valued?

Rather than “shares”, mutual funds are usually bought and sold in “units”. When you invest in a mutual fund, you buy units of the fund along with other investors. As new people invest in that mutual fund, new units are issued.

The price of mutual fund units is determined by adding up all the fund’s assets, minus its liabilities, divided by the number of units outstanding. This is what’s known as the net asset value (NAV), which will fluctuate depending on the performance of the mutual fund’s underlying investments. Most mutual funds report their NAV daily. The purchase or sale of mutual fund units is done at that day’s NAV.

How to make (or lose) money on a mutual fund

There are two ways to earn money on your mutual fund: capital gains (or losses) and distributions.

If you sell your mutual fund units for more than you paid for them, you can realize a gain on your mutual fund investment. Conversely, if you sell your mutual fund units for a lower price than when you purchased, you will have a loss.

Your mutual fund may also pay out distributions, depending on the fund you purchased. Distributions consist of dividends, interest, and capital gains the mutual fund earns on the underlying investments. Distributions can be received in cash or can be automatically reinvested in the mutual fund for you.

How mutual funds are taxed

As with any investments, if mutual funds are held within a registered account, such as a registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or registered education savings plan (RESP), the investment income you earn is not taxed until you withdraw the funds. If you hold the mutual funds in a tax-free savings account (TFSA), the income earned is not taxed while in the plan or when it is withdrawn. If the mutual fund is held in a non-registered account, the income earned is taxable. Any distributions would be taxable in the year that you receive them, whether they are received in cash or reinvested.

Benefits of investing in mutual funds

Diversification – Mutual funds are an easy and low-cost way to gain diversified exposure to many types of assets, sectors, geographic regions, and investment themes.

Professional management – Mutual funds are managed by knowledgeable industry professionals.

You can start smaller – Many mutual funds have low initial investment requirements and allow for easy automated contributions/deposits to help you grow your wealth.

Redeemable – A fairly liquid investment, you can sell you mutual funds at the current NAV price at any time.

Risks of investing in mutual funds

Like with most investments, there is risk involved in mutual funds. The level of risk involved depends very much on the type of mutual fund you purchase – and what its underlying holdings are. For example, a money market fund that invests high-quality short-term government bonds and treasury bills would generally be a safer investment with a more stable NAV than a pure equity mutual fund.

Mutual funds are not guaranteed by Canada Deposit Insurance Corporation (CDIC), regardless of what fund company they are issued by. You can lose money investing in mutual funds.

Mutual fund companies publish a fund’s daily NAV and past performance charts showing how the mutual fund has performed over time. However, a mutual fund’s past performance does not indicate or guarantee its future performance. Past performance cannot tell you how it will perform in the future, but it can help indicate how volatile its performance could be.

Mutual fund fees

Mutual funds, like exchange-traded funds (ETFs), charge a management expense ratio (MER) to cover ongoing operating expenses, advisory services, administration, and record keeping – these will differ by fund based on complexity and structure.

In most cases, mutual funds are available in a series (or class), each having a different fee structure to suit different types of investors.

There are also fees associated with the purchase and sale of mutual funds, which vary depending on how you purchase them. Keep in mind that the higher your mutual fund fees and expenses, the more it will reduce your investment returns.

Ready to start investing in mutual funds?

Our knowledgeable wealth advisors can work with you to devise a plan based on your risk tolerance and savings goals. Contact a wealth advisor today.

Qtrade Direct Investing provides many useful tools and resources to help you find and evaluate mutual funds, starting with the comprehensive Mutual Fund Research page. This information hub provides a number of articles on personal finance, fund manager insights and mutual fund insights, as well as listings for the top- and bottom-performing funds, and the largest mutual funds in Canada.

Article Source: QTrade Direct Investing

Thursday | February 20, 09:00 AM