A mutual fund is a pool of investments that sells its securities (called units or shares) to investors who have a common objective.
Managed by professional portfolio managers, mutual funds allow you to diversify your portfolio by investing in a number of different investments. Mutual funds can invest in equities, bonds, or other mutual funds, and may specialize by industry, sector, or country.
Mutual funds generally fall into three different categories: money market funds, bond funds, and equity funds.
When you purchase a mutual fund, the Fund Facts document will be delivered to you before the dealer accepts your instruction to buy fund units. This document will include a description of the fund, as well as the performance information, risks, and costs of buying and owning the fund.
The Canadian Securities Administrators (CSA) offers a brochure on Understanding Mutual Funds.
What Risks do They Have?
Each mutual fund has a different level of risk depending on the fund manager’s investment strategy, and the different types of securities, such as money market instruments, bonds, equity securities, or securities of another mutual fund in which the fund invests. Unlike segregated funds, mutual funds do not offer maturity guarantees.
There are risks common to any mutual fund, such as the risk that you will lose money due to the management fees charged to the fund. This chart shows the risk of a variety of mutual funds.
Money Market Funds
Risk Level: Low
Risk Source: Money market funds invest in short-term guaranteed investments such as government bonds and T-Bills. These funds are a good place to keep money that you need to access right away. Pay attention to the management expense ratio (MER) of the fund. If interest rates are low, there is risk you will not stay ahead of inflation.
Risk Level: Low to Medium
Risk Source: Unlike individual bonds, bond or fixed income funds don’t have a maturity date, so there is no certainty of getting your principal back. If interest rates are low, much of the interest from the bonds goes to paying management fees. For more information about bonds, see our Bonds page.
Equity Mutual Funds
Risk Level: Medium to High
Risk Source: Varies from fund to fund. The risks of an equity fund are like the risks of stocks, with the benefit of diversifying between numerous stocks. For more information about shares, see our Shares page.
Country- or Sector- Specific Funds
Risk Level: High
Risk Source:These funds are less diversified than other funds and this makes them risky investments. A foreign fund also has foreign currency risk, where you could lose money if the exchange rates change.
Can You Sell Them Easily?
Yes. Mutual funds are popular and highly liquid. Mutual fund companies are generally required to buy/redeem units at a fund’s net asset value (NAV) at the end of each trading day.
If you sell a fund soon after buying it, you may be subject to an additional fee called a short-term trading fee.
What are the Costs?
Mutual funds can have high associated costs. As with any investment fund, there are management fees, operating expenses, and possible trailer commissions that make up the mutual fund’s MER.
Sales charges may apply when purchasing mutual funds. Funds may be offered with front-end load or initial sales charge, back-end load or deferred sale charge, or low load or no load.
If you have a fee-based account, you do not pay a sales charge when you buy and sell funds. Instead, your advisor charges a fee every year to your account.
What are the Expected Types of Returns?
Mutual funds may pay a regular distribution. If so, you should ask how much of this distribution comes from interest or dividends the fund earns, and how much is a return of capital.
If the fund you hold does not pay a regular distribution, you will realize your return only when you sell your units back to the fund company. At this point, you will get capital gains if the NAV has increased, or capital losses if the NAV has decreased.
Mutual funds often do not outperform their benchmark indices once you take into account their MER.
Finally, mutual funds must hold a portion of their portfolio in cash to fund redemptions. This means they will never invest 100% of the money you invest. This can reduce their returns.