When it comes to investing, one of the most popular products, if not the most popular, is a mutual fund. This type of investment product is available to all investors, but many still don’t know what is a mutual fund.
To simply put it, a mutual fund is an investment product that consists of stocks, bonds, and other investments that are chosen by a professional fund manager. The money you put into this fund is pooled with other investors (hence the term mutual). With this strategy, you’re able to buy a mix of investments that you may not normally have been able to. Mutual funds can be purchased and placed within your RRSP and/or TFSA which is another reason why they’re so appealing.
How to invest in mutual funds
Investing in mutual funds is easy since you can purchase them from a bank, investment firm or robo advisor. Selecting the mutual fund can be the tricky part. You basically want a fund that matches your risk tolerance and your timeline.
For example, if you’re in your 20’s, investing in a mutual fund that has more equities (riskier investments, but bigger potential return) probably makes sense. Now, if you’re someone in your 50’s, having a fund that has more fixed income investments (safer assets) is likely the best choice.
Although mutual funds can help you diversify your investments, they can be quite costly. Every fund has a management expense ratio known as the MER which is paid to the fund manager/firm regardless if your investments go up or down in value. With mutual funds, the average MER can be over 2% which is why low fee index funds from robo advisors such as RBC InvestEase, Justwealth and Wealthsimple have become so popular over the years.
Types of mutual funds
I’ve sort of touched on the basics of mutual funds, so now I’m going to go into a bit more details about the different types of mutual funds. The idea here is to educate yourself so when you’re ready to invest, you know what type of funds you’re buying. Keep in mind that there are more than 10,000 mutual funds out there so I can’t comment on the best mutual funds. You should also understand that past performance is not indicative of future results so it’s not realistic to expect a fund that has performed well in the past to continue to do so in the future.
Equity funds consist of shares in publicly traded companies and are focused on growth. They’re attractive to investors who are willing to take more risks in their portfolio, but it’s unlikely investors are only invested in equity funds. They typically have another fund to balance them out.
What makes equity funds appealing is that you’re able to diversify into a ton of different companies instead of picking just a few and hoping that they perform well. Have you heard of the term “a basket of stocks,” that’s what an equity fund is.
For those looking for investments that are safe and pay out a defined amount, then fixed-income funds will appeal to you. These funds are very safe and provide a steady stream of income. Younger investors may like the idea of guaranteed returns, but these types of mutual funds are aimed at older investors who have already seen their money grow.
A fixed-income fund will consist of investments such as government and corporate bonds of a high grade so there’s no real worry that your money will go down in value. Your money won’t really grow in a fixed-income fund, but it’ll pay more than keeping your money in a chequing account.
Money-market funds are similar to fixed-income funds in the sense that they invest in fixed-income investments. I’m talking things such as certificates of deposits (known as CDs), short-term debt from corporations and the government, and even commercial paper which is sold by large corporations to meet short-term debt.
If you’re looking for the safest investment possible, then money-market funds are the way to go, but to be realistic, you should only be using them to park your cash until you figure out what you want to do with your money.
For most people, balanced funds are the way to go since they mix equities with fixed income. The ratio of equities vs. fixed income varies by the fund, but as you can imagine, the ones with more equities are riskier compared to those with more fixed income. This mixture of equities and fixed income is known as asset allocation which may be a term you’ve heard of before.
Target funds for Registered Education Savings Plans are a type of balanced fund which is incredibly popular since you’re basically picking the year where you need the money and the fund balances itself (well, the fund manager does it).
When it comes to mutual funds, index funds are my favourite since their fees are quite low compared to mutual funds. You can purchase them yourself, through a robo advisor or even via a bank such as Tangerine.
Basically, index funds are built to track a specific index such as the S&P 500 whereas fund managers pick individual stocks for say equity funds. Since they track an index, you’ll get average returns, but history shows that index funds outperform mutual funds 90% of the time so getting the average is a good thing.
Which mutual fund should you choose?
I can’t tell you what specific funds to invest in, but I personally use TD e-Series funds and all-in-one ETFs. The fund you choose should depend on your goals and timeframe. If you’re still not sure what to do, working with a robo advisor is likely the easiest way to go.