What Are Mutual Funds?
A mutual fund is a popular investment as well as an investment vehicle. These mutual funds hold numerous types of securities for investing such as stocks and bonds. The objective is for the money managers to take the collective money and generate income for their investors. There are often targets that money managers try to accomplish to satisfy their goals and the goals of their investors.
How Do Mutual Funds Work?
Investing in mutual funds work similar to other companies. If you invest in any company, you’re investing for part ownership of that companies assets. Dividends are paid out depending on the company.
When investing in a mutual fund, the fund has a variety of different stocks and bonds that it invest in. This means that your money is being allocated to a multitude of different investments. If you invest into Bell Canada and news came out that affected the stock negatively, your investment would decrease significantly. However, if that stock was within the mutual fund, your investment would not take such a big hit because of its only a small part of the overall portfolio.
Types of Mutual Funds
There are many types of mutual funds and each has a different way of generating income for its investors. One of the main mutual funds would be a fixed income mutual fund. These funds focus on generating copious amounts of income through interest rates on various amounts of bonds. The fund invests into these bonds and then pass on a certain amount of interest income to their investors/shareholders.
Asset Allocation Fund
A mutual fund that focuses on investing into both stocks as bonds with the primary goal of mitigating or reduce risk. However, these funds are as risky as any other investment. The primary goal is to gain appreciation while maintaining a relatively low level of risk.
If you’re more cost sensitive than an index fund might be the right path for you. These funds do not look to invest in a plethora of different stocks and bonds. Their primary goal is to invest in the market index such as S&P 500. These are often the easier choice for the cost sensitive investor because these funds require fewer employees to do analyst work which means it does not cost as much to operate the business.
Canadian Equity Market
If an investor would like to invest in the Canadian equity market they’re in luck because they would be able to invest in the S&P/TSX Composite Index. This index encompasses approximately 95% of the Canadian equity market. Financial, energy and material sectors make up most of the market.
How Much Do Mutual Funds Charge?
Mutual funds typically have two types of fees, these fees are operating and shareholder fees. The operating fee is a standard fee that is charged on an annual basis for the management. Operation fees of a firm usually range from 1-3%. The shareholder fee is a commission that is paid when purchasing or selling funds, similar to buying stock through a bank.
There are many benefits in investing in a mutual fund such as:
Diversity: One major benefit, as stated previously is the amount of diversity a mutual fund can bring to an investors portfolio. Choosing to invest in a mutual fund is like putting your eggs into a lot of baskets instead of one.
Investing in one company directly effects your full investment. However, when investing into a mutual fund your money is diversified, where if one stock does bad it won’t necessarily hurt your investment too much because there are other stocks to balance out the depreciation.
Fees: Lower amount of fees can be another benefit that would be enticing to many investors. If you’re self-managed and wanted to create a diverse portfolio with different stocks in different industries. You would pay commissions off buying and selling each and every stock. If you invest in a mutual fund, you would only have to pay those fees. The rest of the diversification is taken care of by the mutual fund.
There is no need to pay commissions on every stock. It is also perfect for those who have a low amount of capital to invest. This is because typically a few hundred dollars is not enough to buy copious amounts of a particular stock (depending on the stock of course) but it most likely would be able to buy many mutual fund shares.
Accessibility & Management: Mutual funds are highly accessible and can be bought or sold without many obstacles. Plus, certified investment advisers are managing the more. They most likely have a team working for them in order to generate the most income.
Mutual Funds have their fair share of cons:
Unstable Returns: Just like any other investment, there is always a risk when investing and mutual funds are not different in this aspect. Mutual funds are definitely better than a lot of other high-risk venture but there are is always a chance that the value of the mutual fund will decrease, causing a lower return than originally expected.
Managing Cost: As previously mentioned, there are operating costs that are correlating with managing a mutual fund and these fees are charged regardless of performance. This means that if a fund does not make any money from your investment, you will still have to pay that operating fee.
Over-Complication: Mutual funds can make the mistake of over-complicating their diversity when investing. Many times a mutual fund will invest their assets into fields that are too closely related. When doing this the mutual fund will sometimes lose the benefits of decreasing risks, causing unexpected or bigger losses.
Cash: Although it is not really that much of a major deal, considering the fact that mutual fund companies constantly have investors investing and withdrawing money, they must keep a large sum of liquid cash. This is essentially cash that is just sitting there and not being invested in order to generate greater returns.
Christopher is just a man on a mission to help those around him gain financial success. Obsessed with writing about all things finance, this GTA native is constantly learning and sharing his experiences with others.