What Exactly Is Mutual Fund & How Do They Work? Types Of The Mutual Fund.
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What Exactly Is Mutual Fund & How Do They Work? Types Of The Mutual Fund.

What is Mutual Funds

A mutual fund is a group of investments in stocks, bonds, or other securities paid for by units owned by individual investors. The strategy of a mutual fund may focus on a certain sector, region, or asset class, or it may invest in several different asset classes. Mutual funds offer some diversification because they hold many different investments.

Portfolio managers are in charge of running mutual funds. They buy and sell the securities in the fund’s portfolio and watch the market. Many funds are actively managed, which means that the portfolio manager chooses securities based on their investment philosophy and best judgment to beat the market.

Other funds, called index funds, are passive investments that try to match a market index, like the S&P/TSX Composite Index of Canadian stocks. In either case, all investors pay for the costs of transactions and running the fund.

Mutual funds are not listed on a stock exchange, so they can be traded and priced all the time. Instead, mutual fund companies sell their shares, also called “units,” to investors. When investors sell their shares, the mutual fund companies buy them back. New shares may be issued if investors want more shares than are being redeemed.

Why Should I Invest Money in This?

Most mutual funds require at least $500 or $1,000 to be invested first. Most of the time, the next investments are for $50, $100, or $500.

How are the prices of mutual funds decided?

The value of a mutual fund changes every day based on how much its investments are worth. The price at which you may purchase or sell shares of a mutual fund is determined by the fund’s net asset value per share (NAVPS).

NAVPS = Total market value of assets minus total liabilities / Total number of outstanding shares (units)

Most mutual funds figure out their NAVPS every day, but some do it once a week or once a month.

What Is the MER?

The annual fees and operating costs of a mutual fund are shown as a percentage of the fund’s average net assets by the management expense ratio (MER). These compensations come out of the fund before the return is calculated, costing investors a roundabout.

The MER is written in the fund’s prospectus, usually between 1% and 3%. Some funds have fixed MERs to make it easier to figure out how much it will cost to invest. This means that the MER stays the same for one year.

MER’s Implications

Many investors like mutual funds because they are professionally managed, and they are also seen as a cost-effective way to invest. But over time, the cost of the MER can have a big effect on your portfolio because it adds up. Lowering the MER can help a portfolio do better over the long term. Keep in mind, though, that the management of each fund is different. You’ll only get part of the picture if you only look at a fund’s MER.

Steps to Take Prior Investing in a Mutual Fund

  • Know what you want to achieve with your investments and how much risk you are willing to take. This will help you create a good investment strategy.
  • Check out the funds with Screeners.
  • Check out the fund’s prospectus, which is usually on the fund company’s website (or at sedar.ca). Ensure that the mutual fund’s investment goals are the same as yours.
  • Check the fund’s prospectus to see if it can give you the return you want in the amount of time you set. Remember that how well you did in the past does not mean that you will do well in the future.

Examine the fund’s portfolio manager’s historical performance and compare it to other funds or indexes in the same asset class or style.

Money Market funds

These funds offer the least risk to investors of the three asset classes. The underlying investments are a mix of short-term debt, usually focused on Canadian or U.S. markets and have a low chance of making money but are very safe.

Fixed-Interest Funds

As the name suggests, these funds are meant to bring in money. The funds tend to be safer investments than most equity funds because they focus on stability and income rather than growth. But because the credit quality of investments varies, fixed-income funds may have very different risk profiles.

For example, a high-yield bond fund has more risk than a bond fund that only buys government debt. Other types of fixed-income funds can be told apart by their average duration:

  • The Short-term is less than 3 years.
  • Medium-term: 3–10 years
  • Long-term: More than 10 years

Equity funds

Stocks are bought with these funds. You can learn more about the fund’s style from the fund’s prospectus. Like Canadian-Focused Small/Mid Cap Equity Funds, some funds only invest in companies of a certain size. Others focus on a certain country (Japanese Equity, for example) or business sector (e.g. Health Care Equity).

Most equity funds want their investments to grow and make more money. On the other hand, some will also pay attention to dividend income (e.g. Canadian Dividend & Income Equity).

Some equity funds try to match the performance of an index. These funds are called index funds, which is a good name. Still, others stick to a certain way of investing. For example, they might only invest in companies they think are good for society or the environment.

Balanced funds

These funds give investors a mix of safety, income, and growth in their investments’ value. They will hold fixed-income securities for stability and income and a wide range of common stocks for diversification, dividend income, and growth potential. But the amount of the fund that goes to each asset class and the quality of each asset are not the same. The Canadian Fixed Income Balanced, the Global Neutral Balanced, and the Global Equity Balanced are all types of balanced funds.

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Written by Finance Guru

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