What are mutual funds?
Mutual funds are funds in a portfolio of many individual investors that are aggregated for investment purposes. Mutual funds, hedge funds, exchange-traded funds, pension funds and mutual funds are all examples of professionally managed mutual funds. Investors in mutual funds benefit from economies of scale, which allow them to reduce trading costs per dollar of investment and to diversify.
Key points to remember
- Mutual funds pool the capital of a number of people, investing like a giant portfolio.
- Many mutual funds, such as mutual funds and mutual funds (UTIs), are managed by professionals.
- Mutual funds allow an individual to access scale opportunities accessible only to large institutional investors.
The basics of mutual funds
Groups such as investment clubs, partnerships and trusts use mutual funds to invest in stocks, bonds, and mutual funds. The joint investment account allows investors to be treated as a single account holder, which allows them to buy more stocks collectively than they could individually, and often at better discounted prices.
Mutual funds are among the best known mutual funds. Actively managed by professionals, unless they are index funds, they distribute their assets over different investment vehicles, thereby reducing the effect of all or part of the securities on the overall portfolio. Because mutual funds contain hundreds or thousands of stocks, investors are less affected if a stock underperforms.
Another type of mutual fund is the unit investment trust. These mutual funds take money from small investors to invest in stocks, bonds and other securities. However, unlike a mutual fund, the unitary investment trust does not change its portfolio during the life of the fund and invests for a limited period.
Advantages and disadvantages of mutual funds
With mutual funds, groups of investors can take advantage of the opportunities usually reserved for large investors. In addition, investors save on transaction costs and further diversify their portfolios. Because funds contain hundreds or thousands of stocks, investors are less affected if a stock underperforms.
Professional management ensures that investors receive the best risk-return compromise while aligning their work with the fund’s objectives. This management helps investors who may lack the time and knowledge to fully manage their own investments.
Mutual funds, in particular, offer a range of investment options for the very aggressive, slightly aggressive and unwilling to take risks investor. Mutual funds allow the reinvestment of dividends and interest which can buy additional fund units. Investors save money by not paying transaction fees to hold all of the securities in the fund’s portfolio basket while increasing their portfolio.
Diversification reduces risks.
Economies of scale improve purchasing power.
Professional money management is available.
The minimum investments are low.
Commissions and annual fees are incurred.
The activities of the fund may have tax consequences.
The individual lacks control over the investments.
Diversification can limit the increase.
When money is pooled in a group fund, the individual investor has less control over group investment decisions than if he were doing it alone. Not all group decisions are the best for every individual in the group. In addition, the group must reach consensus before deciding what to buy. When the market is volatile, taking the time and effort to reach an agreement can remove opportunities for quick profits or reduce potential losses.
When investing in a professionally managed fund, an investor relinquishes control to the fund manager who manages it. In addition, it incurs additional costs in the form of management fees. Charged annually as a percentage of assets under management (AUM), the fees reduce the total return of a fund.
Some mutual funds also charge a sales charge or expense. Funds vary depending on when these fees are charged, but the most common charges are front-end charges – paid at the time of purchase and primary charges – paid at the time of divestment.
An investor will deposit and pay taxes on the capital gains distributed by the fund. These profits are distributed equally among all investors, sometimes to the detriment of new shareholders who have not had the chance to benefit over time from the assets sold.
If the fund often sells assets, capital gains distributions may take place each year, increasing an investor’s taxable income.
Example of a mutual fund
The Vanguard Group, Inc. is one of the world’s largest investment management companies and pension providers. The company offers hundreds of different mutual funds, ETFs and other mutual funds to investors around the world.
For example, its Canadian subsidiary, Vanguard Investments Canada, offers Canadian investors many mutual fund products. These products include 39 Canadian ETFs and four mutual funds, as well as 12 target retirement funds and eight mutual funds – the latter two are offered to institutional investors.
One of the mutual funds, the Vanguard Global ex-Canada Fixed Income Index Mutual Fund (hedged into Canadian dollars), invests in foreign bonds. In April 2019, it took a new benchmark – the Bloomberg Barclays Global Aggregate ex-CAD Float Adjusted and Scaled index – to take advantage of the inclusion of Chinese government bank bonds in its Canadian portfolio.