Mutual Funds


What’s All the Fuss About?

These days, one cannot help but read about mutual funds. Mutual funds are first and foremost in financial newspapers and money management books. Magazines and billboards prominently display names of mutual fund companies and advertise impressive rates of return.

So, what is all the fuss about mutual funds? To get an idea, we need to look at investing, particularly investment attitudes and how mutual funds have come to exist.

To over-simplify, there are three types of investors: conservative, aggressive and balanced. Conservative investors put their money in rock-solid investments, generating a low return that is fully guaranteed. Aggressive investors typically play the stock market, and depending on the strength of their stomach, the returns are sometimes good, sometimes bad and definitely not guaranteed. Balanced investors diversify their holdings among guaranteed and non-guaranteed investments, with a long-term approach to the rate of return.

Experts estimate that as Canada’s baby boomers age, they are destined to inherit more than a trillion dollars. This huge transfer of wealth means there are a lot of people with money to invest. At no other time in Canada’s history have as many people had as much wealth as those living today.

Mutual funds offer a middle ground between the conservative and aggressive investor, in terms of potential risk and rate of return. When compared to fully guaranteed investments, mutual funds offer a higher potential risk and rate of return. Conversely, the risk is lower than “playing the market,” but so too are the potential returns.

For the balanced investor, mutual funds offer another alternative in a diversified portfolio. This is particularly true when we consider the hundreds of mutual funds that are available today. There are investment opportunities in virtually every part of the world, in every known industry. This is something that is difficult to achieve if you invest in bonds or in Canada’s stock markets.

The popularity of mutual funds is the result of many things: the availability of money, a lack of trust in government retirement programs (and the subsequent popularity of RRSPs), and the emerging global economy, creating a desire to invest and diversify internationally.

Earlier this year, the total amount of money held in mutual funds (net assets) reached $131.9-billion compared with just $24.9-billion at the end of 1990. This total includes both RRSP and non-RRSP accounts.

Just what is a mutual fund, and is it right for you? I spoke to Daniel Tutton, regional vice-president of marketing for 20/20 Financial Ltd., a mutual fund company located in Oakville, Ontario.

According to Mr. Tutton, a mutual fund is simply a financial vehicle through which individuals may invest their money. He told me that with mutual funds, the idea is to achieve better results through collective investing: pooling the investments of thousands, or tens of thousands, of individuals. Investing on a collective basis offers the individual investor professional management at a low cost. There is also better safety. More money means mutual funds can diversify more easily and on a wider scale than the individual, so the risk is more spread out. Finally, mutual funds are a very convenient way to invest.

Conceptually, the operation of a mutual fund is similar to the operation of a bank. In banks, individuals deposit their money and receive interest. They can withdraw their deposits in cash at any time. Their banks employ professional money managers who put the depositors’ money to work, mostly through lending. Mutual funds do the same. Individuals deposit money in a fund in exchange for shares. The fund managers put the money to work either to produce an income, create fund growth or both. Like a bank, the investors have liquidity because their shares can be converted to cash. The greatest difference between mutual funds and banks is that banks guarantee to give back the exact amount deposited, plus interest. Mutual funds do not guarantee the dollar value of investments. However, past experience has shown that mutual funds have returned more to long-term investors than the investors have paid in.

Each person’s share of a mutual fund is based on the total value of the fund and how many shares they hold. The net asset value per share (NAVPS) of a fund is calculated daily by dividing the net asset value of the fund by the number of shares outstanding, the net asset value being the fund’s assets minus liabilities on any given day.

If a shareholder decided to liquidate, they would sell their shares back to the mutual fund, which would repurchase them at the request of the shareholder at any time. One should be cautioned that in addition to the risk of returning less than was paid, some mutual funds carry charges for selling shares.

The next question that comes to mind is, “What’s in it for the person who runs the fund?” The answer is, quite naturally, money. Every mutual fund operator receives a management fee which is taken from the fund. In addition, the expenses incurred in running the fund are also charged to the fund. Fortunately, mutual funds are a very competitive business. This forces each fund company to keep management fees and expenses reasonable. If they are too high, they affect the performance of the fund, and a fund that has a poor performance history won’t attract investors.

In addition to management fees and expenses, all mutual funds include something called a “load.” The load is in addition to management fees and expenses, and is added to the fund to discourage investors from taking their money out too soon. When depositors take money out, it is hard for the fund manager to know how much money there is to invest. This makes it difficult to make long-term investments.

There are front-load, rear-load, level-load and no-load mutual funds. Which type is best depends on what you want to accomplish, and what you think will happen in the future.

Front loads are just that. They are charged when the investor’s share in the fund is established, and are usually based on how much is invested. These fees discourage withdrawal because the load is not refunded.

Rear loads are charged when money is removed from the fund within a certain period of time, usually six or seven years. Some companies allow transfer between a family of funds without incurring their charge. The amount is based on how much is invested.
Level-load funds charge nothing to invest but have an exit fee for a fixed period — say, two years. The exit fee is level and then disappears.

No-load funds are bought directly from a fund company. This load is a flat fee that is similar to the front load. If you withdraw the money, the fee is not refunded.

Today, the number of choices in mutual funds is staggering. Mutual funds allow the individual investor to place money in virtually any industry or type of investment while gaining the expertise of an experienced and proven money manager. Mutual funds also allow the investor to tailor the amount of risk to their profile by looking at the long-term performance of a fund, how much the returns have fluctuated and what the money has been and will be invested in.

As with any financial planning tool, the most important thing is to seek the help of a trusted and competent advisor who has shown you, based on their past performance, that they can offer you the type of risk and return you want.

(Scott Beckett is the Associate Director of Disability Market Development, PPI Financial Group in Toronto.)


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