A mutual fund is essentially a basket of securities and when you buy a mutual fund, you’re buying a share of that basket. Many investors choose to invest in various types of mutual funds because they’re managed by professional portfolio managers. This gives the investor a piece of mind when it comes to investing as they don’t have to worry about watching the market or monitoring their portfolios. For this peace of mind, the manager charges a fee known as the Management Expense Ratio (MER). There are a wide variety of mutual funds to choose from and they have different risk profiles.
Types of Mutual Funds
There are over 5,000 different types of mutual funds, each different than the other. The most common types of mutual funds have a combination of equities and fixed income. Below we’ll go over the most common types of mutual funds that you might run into during your course of investing.
- Money Market Mutual Funds – Money market mutual funds allow Canadians to earn a higher rate of interest from their cash balances. These are low risk investments that allow you to earn interest and access your money fairly quickly, typically a one day settlement. These money market funds invest in short term high quality debt instruments such as treasury bills with the primary goal to preserve your capital.
- Fixed Income Mutual Funds – Fixed income mutual funds invest in short term and long term debt securities such as government bonds, treasury bills, corporate bonds etc. These type of funds aim to preserve your capital while provide you with a regular monthly distributions. In addition, fixed income funds are sensitive to interest rates and may differ by geographic location, credit quality, term to maturity, investment strategies and so on.
- Equity Mutual Funds – Equity mutual funds invest in a basket of stocks. These funds may differ by the type of companies that they purchase. Equity fund categories could include small, mid and large cap funds. Cap refers to the capitalization and size of the companies in the basket of stock purchases. These funds may pay a monthly dividend distribution.
- Balanced Mutual Funds– Balanced mutual funds have an equal combination of stocks and fixed income. Typically, these funds have 50% of the assets in bonds and the other 50% in stocks, however, this can deviate depending on the portfolio mandate. The goal of these mutual funds is to preserve your capital while giving you the opportunity for growth.
- Alternative Mutual Funds – Alternative mutual funds have more freedom to take on risk. These funds typically, hedge funds, are allowed to invest in physical commodities, take position in derivatives such as options and engage in short selling. These types of strategies are typically not permitted in regular mutual funds.
- Funds of Funds – Funds of funds are mutual funds that invest in other mutual funds. These type of funds are typically very diversified often holding over 10 different mutual funds in their portfolio. These types of funds are also known as multi-manager investments.
If you’re not sure what types of mutual funds should be included in your portfolio, ask your financial advisor for help.
Advantages of Mutual Funds
- Convenience
- Affordability
- Access to your money
- Professional management
- Diversification
- Access to markets
Mutual funds are typically recommended to individuals who are not comfortable in investing in stocks or bonds by themselves. There are many types of mutual funds but the benefits are roughly the same. Mutual funds have continuous oversight that might make a novice investor comfortable knowing that their money is managed by a professional portfolio manager.
Every mutual fund provides a document called Fund Facts for investors. This includes the fund’s risk rating, based on the past volatility of the fund’s returns. The volatility of the fund would be expressed as the standard deviation. The higher the standard deviation, the more volatile the fund is. Make sure that you always review a mutual funds fund facts before investing.
