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Key takeaways:
Even if you don't own a mutual fund or know exactly how they work, you've likely heard people talk about them as one way you can invest. Mutual funds have been one of Canada's most popular financial products for decades, with 59% of Canadian investors having them in their investment portfolios.1
Mutual funds deliver instant diversification and professional money management in a cost-effective vehicle that’s easy to access.
If you want to learn more about mutual funds and understand why they've stood the test of time, we're here to help.
A mutual fund is a professionally managed investment that pools money from different investors to invest in assets like stocks, bonds, short-term money market instruments or other securities. Supported by a team of analysts, a portfolio manager is responsible for investing the money with the intention of meeting a specific goal for the fund.
For instance, the overall goal might be to generate long-term growth or income. This will determine how your money is invested — does it go into stocks, government bonds, exchange-traded funds (ETFs), or other asset classes?
How can a mutual fund help you achieve your long-term financial goals? There are four key benefits of adding mutual funds to your overall investment strategy.
1. Diversification
You've likely heard the phrase, "Don't put all of your eggs in one basket." It may be an old expression, but it holds up.
This same strategy can be applied when it comes to investing. A single mutual fund can give you access to a range of securities to help you balance your risk and reward. If one investment is down, those losses can often be offset by another of the fund’s holdings. Diversification also helps reduce swings in the value of your investment. This can be less risky than investing all of your money into a single company’s stock.
2. Professional money management
If you don't know much about investing or simply don't have the time to micro-manage your portfolio, you can benefit from a professionally managed mutual fund. When you invest in a mutual fund, a professional fund manager selects the securities within the fund and continually monitors the holdings. A professional manager’s investment knowledge and experience can be an invaluable resource.
3. Cost-effectiveness
When you buy or sell a stock, there's usually a commission associated with the transaction. In addition to the time, knowledge and research, commissions can really add up when building a diversified portfolio on your own.
Mutual funds deliver access to a diversified basket of securities in one single investment. They also offer low investment minimums, so if you're a new investor, you can easily get started with an initial investment of $500 or less in many cases.
4. Access and convenience
Mutual funds make investing easy for several reasons. First, all mutual funds allow you to buy or sell your fund units daily. Second, if your mutual fund distributes dividends, interest or capital gains income, you can choose to automatically reinvest the income to buy units. Third, you can set up Pre-Authorized Contributions to invest a fixed amount of money regularly. Additionally, mutual funds deliver access to a wide array of markets worldwide, which wouldn’t be easily accessible to everyday investors.
Although there is a seemingly endless variety of mutual funds available in Canada to meet varying risk profiles, goals and interests, five of the most popular types of mutual funds include:
1. Portfolio Solutions
Portfolio Solutions make investing less complicated by providing a complete diversified solution that’s professionally managed to help you stay on track with your investment goals. Portfolio Solutions have a mix of different investments, like stocks and bonds, carefully selected, combined and continuously monitored to manage risk and take advantage of opportunities.
Typical Investment Objective: Varies, but aligned with long-term goals
2. Equity Funds
Equity funds invest primarily in stocks and generally assume a higher level of risk in pursuit of a higher level of return. The range of equity funds is extensive, but common sub-categories include geography (for example, Canadian, U.S. or global equity funds), company size, investment style (for example, growth or value) or even industrial sectors (like finance, energy and technology).
Typical Investment Objective: Long-term growth
3. Fixed Income Funds
Fixed income funds, also called bond funds, primarily invest in government and corporate bonds. When you invest your money in a fixed-income fund, you can often expect to earn income in the form of interest.
While the total return potential of fixed income funds is lower than equity funds, the risk assumed is also generally lower.
Typical investment objective: Regular income
4. Balanced Funds
If an equity fund feels too risky, but a fixed income fund feels like you're playing things a little too safe, then a balanced fund might be the right fit.
Balanced funds are a popular type of mutual fund focused on offering a blend of long-term growth and regular income by investing in a mix of stocks and bonds. Given their dual role, these funds typically carry less risk than equity funds and more than fixed-income funds.
Typical investment objective: Long-term growth and income
5. Index Funds
If you want to keep your investing costs down, you might consider an index fund. Index funds are passively managed funds designed to replicate the performance of a specific benchmark. For instance, a fund might track the S&P 500 Index or the S&P/TSX Composite Index. The goal of an index fund is to track the performance of the reference index as closely as possible.
Typical investment objective: Varies according to the type of index fund, such as equity or fixed income
Before buying an investment, it's important to clearly understand all of the associated costs. You can expect to see two different fees associated with mutual funds — a management expense ratio (MER) and sales charges.
Management Expense Ratios (MERs)
A fund's MER represents the annual fee for running and servicing a mutual fund. It's shown as a percentage of the fund's assets and varies based on the investment fund you purchase. While fees can vary from fund to fund, the MER generally consists of four distinct inputs: a trailing commission, an investment management fee, taxes and fixed administration fees (and other fund costs). A trailing commission covers the cost of the advice and service you receive from your financial institution (and your advisor) and can vary depending on the fund chosen and the particular fund provider.
Sales charges
Sales charges are the commissions that you may have to pay when you buy or sell a fund (also known as “the load" of a fund). A front-loaded fund requires you to pay this charge when you purchase the fund. A back-end loaded fund requires you to pay the charge when you sell (this is no longer permitted). Today, many mutual funds — including those Scotiabank sells — are sold on a “no-load" basis, which means there's no sales charge when you buy or sell. Make sure you speak with your advisor to fully understand all of the fees associated with your investment.
Like most investments, mutual funds come with a certain amount of risk. While mutual funds are a great way to diversify your portfolio, they still experience volatility. Volatility is a measure of how much an investment fluctuates. A highly volatile investment can move way up or down in price, creating more risk — but also carries the potential for more reward.
For instance, an equity fund usually presents a higher level of risk (and potential for reward) than a bond or fixed income fund, but this isn't always the case.
Unlike your bank account, mutual fund investments aren’t covered by the Canada Deposit Insurance Corporation, the Autorité des marchés financiers' fonds d'assurance-dépôts (Québec) or other deposit insurance. This goes for all investments in stocks and bonds.
To learn more about the risk associated with a particular fund, you can read through the Fund Facts and Simplified Prospectus documents. Or, talk to an advisor.
The short answer is that the best mutual fund for you depends on your unique investment goals, risk tolerance and preferences.
A Scotiabank advisor can work with you to create a customized financial plan complete with investment recommendations that include mutual funds to help you manage today’s priorities while preparing for your future needs – whether that’s retirement, buying a home or funding your child’s education.
