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Like many other types of investments, mutual funds have faced some challenges in the past few years. But for most investors, mutual funds still represent the easiest and most affordable way to take part in the growth of the markets and the economy.
To find out more about the many advantages of mutual fund investing, click through the links below.
An Easy Route to Diversification
Diversification is the cornerstone of reducing risk and achieving investment success. To help you achieve adequate portfolio diversification, many experts say that you need at least 15 to 20 stocks, usually more. But for the average investor, committing enough cash to build a diversified portfolio of stocks is a difficult proposition.
Mutual funds are one solution. A mutual fund pools the resources of a number of investors into a single fund that is managed on their behalf by a fund manager. Each fund can hold a number of different individual investments, such as stocks, bonds, and Treasury bills. Often, as in the case of a balanced fund, they hold all of these investments — so the individual investor can have a diversified basket of securities with just a single investment.
Potential risks: Although their built-in diversification is one of their real advantages, investors shouldn't assume that all funds are created equal.
A typical Canadian equity fund, for instance, will hold a number of securities. But if the fund has significant holdings in high-growth technology stocks, investors may be exposing themselves to greater risk than they assumed. Your advisor can help you examine a fund's holdings to ensure that it is not over-concentrated in riskier investments.
Another area where your advisor can help is in avoiding duplication. For instance, if you own a Canadian equity fund and a Canadian resource fund — and the equity fund has large holdings in the resource sector — you may not be getting adequate diversification. Your advisor can help you select funds that work together to help manage risk.
Professional Management and Expertise
Most of us don't have the time and resources to research the world's markets for investment opportunities. Mutual fund managers do. It's their job to manage money and make day-to-day investment decisions for you, based on extensive research. This process may include meetings with company executives.
Fund managers also have access to sophisticated tools that allow them to screen potential investment candidates. And it won't cost you a lot to take advantage of this expertise.
Affordability and Convenience
Most mutual funds come with low minimum investments, some as low as $500. What's more, after you make an initial investment, you can often make regular contributions with as little as $50 per month.
Automatic reinvestment
Most mutual fund companies automatically reinvest income distributions (from dividends, interest, and capital gains) in additional fund units for you. In a registered plan, such as an RSP, this leads to increased tax-free compounding over time.
Your money is not locked in
Mutual funds are highly liquid investments, meaning that it is easy to buy and sell fund units. Should you need your money, you can usually access your funds quickly. However, most fund companies will charge you an early redemption fee if you withdraw your money within three months of purchasing a fund, with the exception of redemptions from money market and other cash equivalent funds.
Keep an eye on costs
Although mutual funds make it easy to invest, it's important to understand the costs involved. All mutual funds charge a Management Expense Ratio (MER), which covers the fees paid to the investment manager and all administrative expenses incurred in running the fund. These fees are deducted from the fund's assets on an ongoing basis. The MER shouldn't be the sole consideration in choosing funds, but it should figure in your overall decisions.
Some funds (called "load" funds) also levy a sales charge to purchase the fund. When you buy a "front-end load" fund, the charge is deducted from your initial investment, meaning less of your money goes to work for you. "Back-end load" funds do not levy an up-front charge, but if you sell the fund before a certain time, you will be charged a redemption fee.
As the name suggests, "no-load funds" do not charge you to buy or sell a fund. Again, although purchase costs shouldn't be the sole reason for choosing one fund over another, they are an important factor to consider — particularly as costs can add up over the longer term.
Access to Global Investments
For most of us, it can be difficult and costly to access more specialized opportunities, such as international investments. Not so for large mutual fund companies, which have the size and resources to bring these investments to the average investor in a convenient and packaged form, such as a global mutual fund.
Mutual funds also provide access to a range of other more targeted opportunities, including:
Sector investing. Investing in sectors, such as health care or technology, may offer greater opportunities for growth. But sector investing comes with greater risk and often requires specialized expertise to identify opportunities. Mutual funds can bring these opportunities to the average investor. What's more, they can help to reduce risk by holding a diversified basket of sector-specific securities.
Management styles. Each mutual fund is managed according to a particular investment mandate, such as growth (identifying companies that are growing their earnings quickly) and value (identifying undervalued companies). Depending on where we are in the economic cycle, certain styles will outperform others. Holding some of each can help to reduce overall portfolio risk.
Find the Funds That are Right for You
There are more than 4,000 mutual funds available to Canadian investors. This is both a blessing and a challenge. The good news is that there are funds for every type of investor and investment strategy — equity funds, international funds, bond funds, and money market funds. The challenge is combining these funds in a way that meets your goals. Your advisor can help you select the right combination of funds that work together to achieve adequate diversification and reduce risk.
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