> Top 10 Questions
Top 10 Questions About Mutual Funds
The following answers the 10 most frequently asked questions about Mutual Funds.
- What is an investment fund?
- Are funds risky?
- How do the rates of return offered in funds compare with savings
- What is the minimum amount of money that I can invest in a mutual
- How can I compare the rates of return between different groups of
- How easy is it to liquidate funds?
- What types of funds are available?
- Are funds covered under the Canada Deposit Insurance Corporation?
- How are funds suitable for retired people - and where can one
get advice on investing and buying into funds?
- What does it cost to invest in a fund - and do I need to understand
stock, bond or money markets before I invest?
1. What is an investment fund?
An investment (or mutual) fund is
a corporation or trust which accepts money from public investors and employs a
professional investment manager to place that money in investments that will meet the
fund's objective (i.e. produce the kind of return that the fund has stated as its aim).
A fund therefore is simply a cooperative means
for many people to pool their savings together and have their investment professionally
managed in the type of investment they choose. This pooled concept is one that allows
numerous investors to put relatively small amounts of money into investments. But those
many small sums add to a large amount of available dollars with which the fund manager can
choose and diversify the investments represented in a specific fund. The investment fund
also offers not only professional money management, but provides full administrative and
accounting services for the investor.
2. Are funds risky?
It's impossible to compare funds
"across the board". Mutual funds not only differ in their financial objectives
but also invest in different kinds of securities that reflect the ultimate objective of the
fund. Thus, depending on the securities the fund is investing in, or the mix of securities
chosen for a specific fund, the element of 'risk' varies substantially.
The fund's objective is what the fund seeks to
achieve by investing. This will determine what kind of securities the fund will buy, and
in what economic sectors or countries.
For example, a fund seeking the highest possible
return on capital may invest in more speculative common stocks than one seeking maximum
income from dividends. The risk in the first objective is much higher than in the second.
You can see, therefore, that the amount of risk
involved is directly related to the fund's objective. Generally speaking, it can be
assumed that the higher the return, the higher the risk involved.
However, mutual funds remove much of the risk
from investing because they are professionally managed by fund managers with many years
experience in portfolio management. For example, in common stock funds, professional
managers select the investments and monitor them carefully and constantly. In addition,
because of the 'pooled' concept inherent in funds, the element of risk is spread, thereby
making funds less vulnerable to market fluctuations.
It should also be remembered that while it may
be considered 'safe' to keep one's savings in cash, there is always the risk that
inflation will, over time, erode the value of those savings.
3. How do the rates of return offered in funds compare with savings
Generally speaking, savings accounts are the
means by which banks and trust companies borrow money from the public and lend it to
companies and individuals at higher rates. The financial institution makes money on the
spread or the difference between the rate it pays on savings accounts and the rate it
charges borrowers. A money market mutual fund, for example, lends money directly to
governments, corporations, and financial institutions and all people who invest through
such funds earn the higher rate. There is no middle man.
The rates of return for
"non-guaranteed" investments, such as common stock funds have, over time,
historically been much superior to that of a savings account with a financial institution.
This is because, in a free enterprise system investors who choose to "share"
ownership of a public business by purchasing common shares are sharing in the fortunes of
the business. If it does well they share profits - if it does badly there are little or no
profits to share. They therefore expect, and get, a higher return for taking this risk.
However, it must be borne in mind that the return on a common stock fund would not
necessarily be consistent from year to year as companies do better in some periods than
4. What is the minimum amount of money that I can invest in a mutual fund?
This varies between one fund and another but
the minimum is quite low for most funds - somewhere in the region of $500 - $1,000 would
be fairly common. In addition, it is possible with many funds to start at a much lower
level if the investor is prepared to make a regular savings commitment and invest in a
fixed amount per month. In such cases the minimum may be as low as $50.00 monthly.
5. How can I compare the rates of return between different groups of
Before specifically answering this question
it should be clearly understood that one should only compare funds of similar types to get
an accurate picture of relative performances. You cannot compare the rates of return
between different types or categories of funds - you have to compare apples to apples,
oranges to oranges.
For example, it is pointless to compare the
results of a fund that invests in oil and gas exploration companies with one that invests
in well-established companies. The risks are quite different, as are the possible returns
on the investments.
Fortunately, the financial press regularly
report the performance of Canadian mutual funds by type. These reports contain average
results over a 1, 3, 5 or 10-year period and are categorized by the investment objective
of the fund. This makes it very simple for the investor who is considering, say, a growth
fund, to compare all similar funds.
6. How easy is it to liquidate funds?
Most funds have their shares or units valued
daily. This means that investors may purchase shares or units on any business day, and in
most cases, may redeem or sell those units or shares back to the fund on any business day.
7. What types of funds are available?
There are hundreds of funds available in
Canada offering a broad range of investment objectives and investing in a variety of
securities and in a variety of geographical locations. For example, there are funds that
invest in Canadian common stocks, US common stocks and international common stocks. There
are also funds that invest in the stocks of specific industries, such as natural resources
or oil and gas stocks. Some funds invest only in gold other precious commodities.
There are dividend funds which aim to maximize
dividend income. In addition, there are bond funds and mortgage funds. There are also
various types of money market or savings funds based on fixed income or guaranteed
investment. Real estate funds invest in real estate. There are balanced funds which
balance their holdings between bonds and stocks, depending on how the manager perceives
economic conditions at that time. Most of the funds available in Canada are open-end
funds, meaning that they issue a continually increasing number of shares and subsequently
purchase these shares back from investors on demand.
8. Are funds covered under the Canada Deposit Insurance Corporation?
9. How are funds suitable for retired people - and where can one
get advice on investing and buying into funds?
Funds are suitable for retired people
provided there is careful selection of the fund's investment objectives. A conservative
approach to the preservation of capital may be desirable as one reaches more mature years.
There may also be increased emphasis on the income needed for retirement. Funds can
provide the means to reach both these objectives.
Information can be obtained from the funds'
management or from The Investment Funds Institute of Canada. Advice on investing,
financial planning and arrangements to purchase fund shares can be obtained from mutual
fund dealers, mutual fund salespersons, financial planners, stock brokers and investment dealers. Mutual funds are
also available from some banks, individual fund management companies, trust companies and
life insurance companies.
10. What does it cost to invest in a fund - and do I need to understand
stock, bond or money markets before I invest?
Basically, all funds charge a management
fee which is a percentage of the value of the assets of the fund. On average it is an
annual percentage of between 1 and 2 percent. There are also the expenses of administering
the fund, which are typically charged to the fund. Together these form the management
expense ratio of the fund. In addition, there may be sales commissions charged on the
purchase or redemption of shares which are paid to the distributing agency. Remember that
commission is paid for the value-added service of investment planning provided by
salespeople. The amount of commission will depend upon the size of the purchase. If you
understand investment, risk factors and tax considerations, funds without sales
commissions (no-load funds) may be investigated.