If you’re investing for the first time, you may have heard about mutual funds but have no clue what it even means!
Mutual funds are a collection of investments, including bonds, stocks, other funds owned by a group of investors, and a portfolio manager. The portfolio manager manages the fund daily and will buy or sell investments according to its investment goals. A mutual fund can either invest in various investments or focus on a specific type of investment.
By purchasing a mutual fund, your money gets pooled along with other investors, and you essentially buy shares or units of the fund. The fund will issue new shares or units as more people invest.
Mutual funds can get held in a Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), and non-registered accounts.
Canadians can gain access to a diverse range of mutual funds.
How to Make Money From a Mutual Fund
There are two methods that you can earn money from a mutual fund in Canada:
- Capital gains – You will have a capital gain if your mutual fund gets sold for more than what you paid for it. You will have a capital loss if your mutual fund gets sold for less than what you paid for it.
- Distributions – Depending on which fund you bought, you can receive capital gains, interest, distribution of dividends, or any other income the fund earns from its investments. You get given a choice to reinvest the distributions back into the fund or receive the cash.
Ensure you understand the fees and expenses associated with a mutual fund, as Canadians get subjected to some of the highest in the world! These fees and expenses reduce your investment’s return. You will pay for some of these fees, and the fund will pay the others.
The Pros of Mutual Funds
Let’s look at a few pros of a mutual fund in Canada:
- Diversification – The concept of diversification is loved by all investors worldwide, and for a good reason! Even if your risk decreases due to a stock performing poorly, it will get offset by a well-performing stock in a different sector in your investment. A mutual fund is perfect for diversifying your portfolio if you don’t have the money to buy individual stocks.
- Guaranteed principle – Several banks will secure your principal investment through their mutual fund options, especially if you leave your money invested with them for more than five years.
- A portfolio manager selects the stocks for you – Portfolio managers get trained to find the best stocks with the highest capital returns, so you don’t have to concern yourself with it.
Cons of a Mutual Fund
Unfortunately, there are always cons to be made aware of:
- Fees – As mentioned before, fees are a killer, especially Management Expense Ratio (MERS). MERS is almost like a commission for the financial advisor and will cover them and the fund manager and any other costs to keep the fund managed. You want to lower all these investment costs to benefit from compound interest over the long term.
- They don’t trade on the Exchange – Trade commissions can get costly every time you trade, but because they don’t trade on the Exchange, you get to avoid paying trade commissions.
It can get difficult to track your fund’s performance – Financial advisors tend to avoid giving updates to their clients and often only send out quarterly reports. To prevent this from happening to you, get the login details from your financial advisor, and keep track of your fund’s performance online.
Where You Can Buy Mutual Funds
Financial advisors usually sell mutual funds the most. Still, you need to ensure they are registered with their provincial regulators, such as the Canadian Securities Administrators or the Ontario Securities Commission.
These advisors also need to be working for a company registered to sell mutual funds. If you prefer to avoid using a financial advisor, you can buy mutual funds directly from a discounted brokerage.
Here are a few more ways for you to purchase mutual funds:
- Life insurance companies
- Mutual fund dealers
- mutual fund companies that publicly sell their funds
- Investment firms
What You Should Know About Mutual Funds
Certain things need to get taken into account before investing in a mutual fund.
How do Mutual Funds Get Taxed
You get subjected to tax if you keep your mutual funds in a non-registered account. Your distributions get taxed in the same year that they were received, whether you reinvested them or took the cash.
If you choose to keep your mutual funds in a registered plan, such as an RRIF, RRSP, or an RESP, you get to avoid paying tax for the plan’s duration. The money will get taxed when you withdraw from these funds. There’s no tax payable if you invest with a TFSA, whether the money stays invested or gets withdrawn.
Before buying mutual funds, ensure you find a financial advisor who has your best interest at heart. Discuss MERS with your advisor, and consider all the options of where you can buy mutual funds.
Consider the fund’s objectives or goals, what risk you are taking, the fees you could be paying, and how you will get taxed.
Continue to educate yourself on mutual funds and read performance reports to get an idea of the fund’s performance. It’s also time to start reading the newspaper or financial news online – there’s a lot for you to research!