What are mutual funds
Mutual fund is a financial instrument which pools the money of different people and invests them in different financial securities like stocks, bonds etc. Each investor in a mutual fund owns units of the fund, which represents a portion of the holdings of the mutual fund. Let us understand with the help of an example. Suppose you invest Rs 100,000 in a mutual fund. If the price of a unit of the fund is Rs 10, then the mutual fund house will allot you 10,000 units. Let us assume the total money invested in the fund by all the investors is Rs 100 crores. The mutual fund invests the money to buy stocks. Then each unit will represent 0.000001% of all the stocks the mutual fund has in its holdings. If you have 10,000 units, then your portion of the mutual fund stock holdings will be 0.01%. As the value of securities held by the mutual increases or decreases, so will the price of the units.
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Why do some investors choose mutual funds?
1.Built-in diversification
2. Professional management
3. Ease of buying and selling
4. There are a wide range of funds to choose from
What questions should you ask before buying mutual funds?
1. What is the mutual fund’s goal?
1. What is the mutual fund’s goal?
3. How has the mutual fund performed?
4. What are the mutual fund’s costs?
5. Who manages the mutual fund?
What are the risks of investing in mutual funds?
Like most investments, mutual funds have risks. Your investment may go up in value, but it may also go down. The value of most mutual funds will change as the value of their investments goes up and down, so you could lose money on your investment if you sell when the value is lower than when you first bought the fund.
The level of risk in a mutual fund depends on what it invests in. Usually, the higher the potential returns, the higher the risk will be. For example, stocks are generally riskier than bonds, so an equity fund tends to be riskier than a fixed income fund.
Some specialty mutual funds focus on certain kinds of investments, such as emerging markets, to try to earn a higher return. These kinds of funds also tend to have a greater risk of a larger drop in value.
How is your mutual fund investment protected?
Because mutual funds are securities, not deposits, they’re not protected by the Canada Deposit Insurance Corporation (CDIC) or other deposit insurance. But other safeguards are in place to protect investors:
- Third-party custodian – holds the assets of a mutual fund. This is usually a trust company or chartered bank
- Independent auditor – reviews and reports on the fund’s financial statements each year.
What happens to your mutual fund if a firm goes bankrupt?
Your mutual funds may be covered by the Canadian Investor Protection Fund (CIPF) if the firm declares bankruptcy. The fund does not cover losses from other causes, such as changing market values of securities, unsuitable investments, or the default of an issuer of securities.
Canadian Investor Protection Fund (CIPF) is a not-for-profit organization. CIPF can return assets to you or compensate you when your assets are not available because a member firm has become insolvent.
How can you research the mutual funds you invest in?
Find out as much as you can about a mutual fund before you buy. A good place to start is with the disclosure documents that a mutual fund company is required by law to file with securities regulators. You can find these on the mutual fund company’s website, the System for Electronic Document Analysis and Retrieval (SEDAR), or you can ask your adviser.
Why do some investors choose mutual funds?
There are a range of reasons why adding mutual funds may make sense for your portfolio. Four main reasons are:
1.Built-in diversification
When you buy a mutual fund, your money is combined with the money from other investors. This allows you to buy part of a pool of investments. A mutual fund holds a variety of investments which can make it easier for investors to diversify than through ownership of individual stocks or bonds.
Not all investments perform well at the same time. Holding a variety of investments may help offset the impact of poor performers, while taking advantage of the earning potential of the rest. This is known as diversification.
2. Professional management
You may not have the skills and knowledge to manage your own investments, or you may not want to spend the time. Mutual funds allow you to pool your money with other investors and leave specific investment decisions to a portfolio manager. Portfolio managers decide where to invest the money in the fund, and when to buy and sell investments.
3. Ease of buying and selling
Mutual funds are widely available through banks, financial planning firms, investment firms, credit unions and trust companies. You can sell your fund units or shares at almost any time if you need to get access to your money. However, keep in mind you may get back less than you invested if you sell when the fund is at a lower value than when you first invested.
4. There are a wide range of funds to choose from
Mutual funds can be used to meet a variety of financial goals. For example:
- A young investor with a stable income and many years to invest may feel comfortable taking more risk to achieve greater potential return. They may invest in an equity fund.
- A mid-career investor trying to balance risk and return more moderately could invest in a balanced mutual fund that buys a mix of stocks and bonds.
- An investor approaching retirement might be less comfortable with risk and more interested in fixed income investments. They may invest in a bond fund.
Video: What is a mutual fund
What questions should you ask before buying mutual funds?
You can find out information about a mutual fund from your investment broker or the financial institution selling the fund. Some information is also in the Fund Facts and other documents describing the fund. It’s a good idea to find out answers to the five questions before you buy.
1. What is the mutual fund’s goal?
Make sure the fund’s goal fits with your investment goals. For example: Does the fund provide regular income? Does it fit with the length of time you plan to invest, and your personal goals? Does it work with your other investments?
2. How risky is the fund?
You can make or lose money on a mutual fund. Does the fund’s level of risk fit with your tolerance for risk? Do you find it difficult to handle price fluctuations? If a fund’s returns vary a lot from year to year, it may be considered higher risk because its performance can change quickly in either direction.
3. How has the mutual fund performed?
It’s true that past performance isn’t necessarily a guarantee of how a mutual fund will perform in the future. But it can give you an idea of how the fund compares to other funds with the same investment objective. Don’t just look at how the fund performed last year. How consistent has it been over the long term? How has it performed in different market conditions? If the fund’s investment objective has changed in recent years, its past performance will be even less of a reliable predictor of its future performance.
4. What are the mutual fund’s costs?
All funds must disclose their fees and expenses in their Fund Facts document and simplified prospectus. Consider all of the costs. For example, a fund with a low management expense ratio (MER) could have very high sales charges, and vice versa. Understand what you’ll pay when you buy or sell units of the fund. Also consider what you’re getting for your money. What level of service and advice will you receive?
5. Who manages the mutual fund?
Much of the success of a mutual fund depends on the portfolio manager’s skill at choosing investments and knowing when to buy and sell them. Consider questions such as: What kind of education and experience does the portfolio manager have? Does the manager run other funds? How successful have they been? What is their investment style?
Find out how stable the fund’s management has been over the years. High turnover can be a warning sign.
What are the risks of investing in mutual funds?
Like most investments, mutual funds have risks. Your investment may go up in value, but it may also go down. The value of most mutual funds will change as the value of their investments goes up and down, so you could lose money on your investment if you sell when the value is lower than when you first bought the fund.
The level of risk in a mutual fund depends on what it invests in. Usually, the higher the potential returns, the higher the risk will be. For example, stocks are generally riskier than bonds, so an equity fund tends to be riskier than a fixed income fund.
Some specialty mutual funds focus on certain kinds of investments, such as emerging markets, to try to earn a higher return. These kinds of funds also tend to have a greater risk of a larger drop in value.
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