Barry Choi
Anyone who wants to start investing will likely come across mutual funds right away. Mutual funds are one of the most popular investment products, and they can help you meet your goals, including retirement or your child’s continuing education costs. However, before you start investing in mutual funds, you need to understand how they work and if they’re a good fit for you.
What are mutual funds in Canada?
Mutual funds in Canada are investment products that invest in stocks, bonds, cash and even other funds. The money you invest into mutual funds is pooled with money from other investors and is managed by a professional money manager. As more investors buy into the fund, additional units or shares are issued.
Mutual funds are appealing since they allow anyone to invest. Because your money is being managed by a professional, there’s no need to worry about your portfolio on a daily basis. Also, since mutual funds invest in multiple products, you won’t have all your eggs in one basket — you’ll be diversified, which can help minimize risk.
There are thousands of mutual funds available, but each one has a specific focus. For example, one fund may focus on growth, while another may prioritize fixed-income investments. Mutual funds can also be global, with some giving you access to markets all over the world. Alternatively, some funds invest in specific countries. Regardless of your goals, there’s likely a mutual fund available to help you get there.
Types of mutual funds
Even though there are thousands of mutual funds out there, they typically fall into one of three main categories:
Fixed-income funds
Fixed-income funds focus on investment products that are low risk, such as bonds, term deposits, Treasury Bills and money market funds. You’ll get consistent income with these funds, but the yields likely won’t be very high.
Equity funds
Equity funds are designed for growth, so they typically invest in stocks. You have a greater chance of higher returns with equity funds, but there’s also more volatility. Different equity funds are available depending on your goals, such as growth stocks, large-cap stocks, etc.
Balanced funds
Balanced funds combine equities and fixed-income securities into a single fund. These types of mutual funds are popular because you can pick one based on your risk tolerance. Conservative funds have more fixed-income assets, while aggressive funds will be heavier on equities.
Purchasing mutual funds is easy since just about every financial institution and investment firm offers them. What’s nice about mutual funds is that you can hold them in taxable and non-taxable accounts, such as your Tax-Free Savings Account (TFSA), Registered Retirement Savings Account (RRSP), trading account and more.
» MORE: How to compare TFSAs and RRSPs
Pros and cons of mutual funds
There’s no denying the popularity of mutual funds. However, it’s important to understand the pros and cons before you start investing in them.
Pros of mutual funds
- Professional management. Mutual funds always have an experienced manager taking care of the fund, so you don’t need to worry about specifics.
- Diversification. Since mutual funds invest in multiple products, you’ll always have a diversified portfolio.
Cons of mutual funds
- High fees. Most mutual funds have a management expense ratio (MER) of 2% to 2.5% — this is significantly higher than the MER of other investment options and can eat into your returns.
- Limited control. Although you can invest in different mutual funds, you can’t control how each fund is managed.
What mutual funds you choose depend on factors, including your risk tolerance, timeline and goals. Regardless of your plans, having a diversified portfolio can help you minimize any market fluctuations.
Mutual fund alternatives
Mutual funds are an excellent choice for many investors, but some people are concerned about the high costs and lack of control. If you fall into that category, a few mutual fund alternatives may be good options for you.
Exchange-traded funds
An exchange-traded fund (ETF) is very similar to a mutual fund because it holds multiple assets. Since the ETF’s investment decisions are usually made using an algorithm, the MER is significantly lower. To purchase ETFs, you must have a discount brokerage account.
Robo-advisors
Despite the name, robo-advisors aren’t run by a bunch of robots. Think of them as online platforms run by real people who build portfolios using ETFs and automated financial decisions. The management fee is generally a bit higher than it would be to manage your investments yourself, but it’s still much cheaper than investing in mutual funds.
Mutual funds and their alternatives are great options for anyone who wants to start investing. Before you make any purchases, make sure you read up on the specific funds you’re interested in and think carefully about how they fit into your investment strategy.
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