8 tips to become a better mutual fund investor

If mutual funds make up most of your investment portfolio, you're not alone. Mutual funds have long been a favoured investment option for many Canadian investors. As of August 2024, mutual fund assets in Canada totalled $2.1 trillion¹, reflecting investors' ongoing trust.

It's not hard to see the reasons for mutual funds' popularity. Not only are they easily accessible — they can be purchased through banks, financial planning firms, brokerages, credit unions and other investment firms — but they also offer investors an easy way to diversify their portfolios.

And most mutual funds, outside of index funds, are actively managed. This means professional portfolio managers, supported by a team of research analysts, do the heavy lifting of identifying and buying investment opportunities for the fund and selling securities that no longer meet the fund's investment objectives.

Before you begin investing in mutual funds, you need to know your investment goals. Are you investing for your retirement? Maybe you want to fund your child's post-secondary education or save for a down payment on a house.

How you invest depends on your goals and personal timeline — for example, whether you're planning for retirement (long term) or saving for a down payment on a home (shorter term).

The first step to understanding your investment goals is to have a financial plan. A Scotiabank advisor can help you build a plan that assesses your current financial and investment objectives. Once you have that in place, you'll be able to see how you can best achieve these goals.

One of the best ways to fuel the growth of your mutual fund investments is to invest consistently. Pre-Authorized Contributions (PACs) help you do just that. With PACs, you control how much and how often you save. The amount you choose will automatically be deducted from your savings or chequing account and deposited into your investment account.

The best part is that by investing automatically with PACs, you can take advantage of an investment strategy known as dollar-cost averaging. This simple strategy is based partly on the principle of “you can't time the market" (timing the market is a strategy where you actively try to buy low and sell high).

With dollar-cost averaging, you invest the same amount consistently, typically monthly, regardless of market fluctuations. This means that when there's a dip in the market, your investment dollars end up purchasing more mutual fund units because during a dip, each unit costs less. This, in turn, lowers your average cost per unit.

Check out this interactive PAC video to see how you can leverage the power of PACs to grow your investments.

Do you know your risk tolerance? Investing always comes with risks, as different factors can impact global markets and your investments — events like increasing inflation, recessions, financial crises and even the COVID-19 pandemic.

One of the keys to successful investing is to know your risk tolerance. A lot of factors go into determining how well you tolerate risk. Some are psychological: for example, how would you react if a severe dip in the market caused your portfolio to drop by 20%? Would you step back and ride out market volatility, or would you be more inclined to sell off your investments so you could lock in your losses?

Other factors include the time horizon of your investment and financial goals, and your personal financial circumstances, like whether you have an emergency fund to draw from should the unexpected happen, such as a layoff or a car repair.

Figuring out your personal risk tolerance can be tough. Your Scotiabank advisor can work with you to help you understand your risk tolerance and then select the right portfolio for you.

Why do you need to focus on diversification when investing in mutual funds? Because when you hold a mutual fund, you’re maintaining exposure to the securities the mutual fund invests in. The challenge is, if your portfolio only holds equity mutual funds, you would leave yourself vulnerable to events like a stock market correction.

Portfolio solutions make investing less complicated. They’re built to help achieve your most important financial goals and are continuously professionally managed to keep you on track. Portfolio solutions carefully combine different mutual funds and other investments into one convenient solution. 

You reduce your risk further by investing in a portfolio of investments across various asset classes (think stocks and bonds), sectors and regions that perform differently under different market conditions.

Mutual funds offer a wide range of investment opportunities that suit your specific needs and preferences.

Common types of mutual funds include:

• Equity mutual fund. Equity mutual funds invest in stocks that can provide you with long-term growth potential. 
• Fixed income mutual fund. A fixed income mutual fund invests in securities or debt instruments that offer regular income and potential for modest capital growth by investing in bonds, such as government or corporate bonds.
• Money market mutual funds. Money market mutual funds invest in liquid, short-term investments, such as government Treasury bills (also known as T-bills). While they typically don't generate high returns, they provide relatively low risk. 
• Balanced mutual funds. Balanced funds provide a balance between income generation and long-term capital growth by investing in a mix of equities and bonds. 

Other options. You can also purchase specific sector- or market-based funds. For example, if you want to invest in environmentally sustainable companies, Scotiabank offers a variety of low carbon mutual funds. And if you prefer a passively managed fund, you can invest in index funds. ScotiaFunds offers a variety of index funds that track Canadian and foreign markets.

Determining the ideal asset allocation mix to diversify your portfolio can be difficult. Ask your financial advisor for guidance on the asset allocations that make the most sense for your unique personal circumstances.

It's important to understand how mutual funds are affected by taxes, since the last thing you want is to have your return reduced by a larger-than-expected tax bill come April.

The first rule of thumb? Consider maximizing your contributions to tax-advantaged savings plans before making investments held in non-registered accounts.

Contributing to a mutual fund held in your Registered Retirement Savings Plan (RRSP), for example, will reduce your taxable income. You aren't taxed on your investment growth until you withdraw the money in retirement. By this time, you'll likely be in a lower income bracket and taxed at a lower rate.

Your investment of after-tax income in a mutual fund in your Tax-Free Savings Account (TFSA) will grow on a tax-free basis and can be withdrawn tax free.

Investment income generated by mutual funds held in a non-registered account, however, will be subject to tax. The amount of tax depends on the type of investment income. Generally, the income mutual fund generate will be taxed as one or more of the following income types:

• Interest income. For example, you'll earn interest income from a fixed income mutual fund that holds bonds.
• Dividend income. If the mutual fund you're investing in holds stocks that pay out dividends (this is only the case if they're from Canadian corporations), the money you earn is taxed as dividend income.
• Capital gains. When your mutual fund sells a security at a higher price than its purchase price, the difference is considered a capital gain.

Each type of income generated requires a different tax treatment. Taxes can get confusing, so it's always a good idea to talk with your accountant about the potential consequences of distributions from your mutual fund investments.

The fees you incur when investing in a mutual fund help cover the cost of managing the fund and will vary depending on which fund you select. It's essential to understand what fees you'll pay, as these fees effectively impact the return you'll get from your investment.

Management expense ratio (MER). A mutual fund is actively managed by a team of investment professionals who do the research and decision-making necessary to identify and purchase optimal investments for the fund. The expenses of maintaining this team, plus trailing commissions, form the central part of a fund's MER. Other elements of the MER include operating expenses and GST/HST.

A fund's MER is calculated as a percentage of the total value of the fund's assets. For example, a mutual fund valued at $10 million with annual expenses of $150,000 has an MER of 1.5%.²

Loads. A fund's load is essentially a sales commission paid to the advisor or broker. Not all funds have a load. Mutual funds that don't have a load are called no-load funds.

There may also be other fees associated with the purchase of mutual fund units such as transaction fees, trading fees and brokerage fees.

Once you've invested in a mutual fund, market conditions may tempt you to sell your mutual fund shares. For example, a dip in the market might prompt you to consider switching out your equity fund for a lower risk money market mutual fund instead.

But while it can be tempting to react to short-term market turbulence by revising your portfolio, the key to successful investing is to keep your focus on the long term. By staying true to your long-term investment strategy, you'll be better equipped to weather the short-term bumps and turns of market volatility that every investor faces along their investment journey.

Cultivating a long-term investment mindset is the best way to stick to your financial plan and meet your investment goals. With a long-term mindset, you can focus on the big picture instead of trying to respond to every short-term market event.