Building Your Wealth: What You Need To Know Before Investing In Mutual Funds

An investment is an asset or item that is purchased with the hope it will generate income or will appreciate to create future wealth. There are lots of types of investments – from stocks and bonds, antiques, art and collectibles, and real estate.

All investments have different ways of being selected and purchased, and each has different risk characteristics. In this series, we’ll look at some of the characteristics of different investment products and how to evaluate them so you can decide if the investment is right for you.

According to the Investment Funds Institute of Canada (IFIC), net sales of mutual funds to the end of June 2017 are a whopping 88% higher than the same period last year – to the tune of $31.1 billion. So, this seems like a logical place to start first.

Chances are you already own mutual funds:

• They are often the only option in employer defined contribution pension plans and group RRSPs. These offer a selection of funds – a few or many – and you choose one or a mix.
• If you are with an investment adviser, mutual funds are likely the backbone of your portfolio.
• You may have purchased them long ago through your bank or mutual fund broker and are either satisfied, or you’re not happy with the returns and fees but you’re procrastinating because you don’t know how to go about switching to something else.

Investing in Mutual Funds

A mutual fund is a collection of investments (either individual securities or other mutual funds) that an investment company puts together and offers to you in the form of units. They are popular because investing in mutual funds is one way to build a diverse portfolio with the least effort.

However, even with a diversified mutual fund, one fund is not necessarily as good as another, and you will have to do some research before you choose.

There are about 17,688 distinct mutual funds currently available in Canada from 455 fund companies, and over 36,000 funds if you consider all the variations of these funds.

Reading a dry-as-dust prospectus is not anyone’s idea of a good time, but at least look at the fund fact sheet. It will tell you what the fund is all about. The investment objectives will tell you who the fund is for e.g. suitable for investors looking for income, maximum growth, long-term gains, etc. Make sure the objectives match your own goals and time frame.

Sometimes less popular funds will be discontinued and merged into another fund. If this happens make sure the objectives are still suitable for your situation.

Even though mutual funds can be an easy way to have a diversified portfolio, make sure your holdings are truly diversified. There is often a redundancy because fund managers tend to pick the same stocks from a limited list – especially true for Canadian equity funds where there’s a relatively small market. Take a look at each of your funds largest holdings to see where there may be duplicates.

Keep an eye on fees

Canadians consistently pay the highest fees for mutual funds of any industrialized country. Apparently (according to Garth Rustand of Investors-Aid Co-op) we pay as much as 60% more than in the US and 200% more than in Europe – yikes!

Are we getting our money’s worth? If you’re not getting great service and investment advice, it might be time to explore some lower expense investment options.

Beware of the closet index fund

These are managed mutual funds whose assets closely resemble the underlying index while charging considerably higher management fees. Research has shown that almost 40% of the equity mutual funds sold in Canada are closet index funds.

Again, take a look at your holdings and compare the list to the comparable index.

Rebalancing your portfolio

One of the best things your can do to maximize your returns over the long term is to rebalance your portfolio. It is also one of the hardest things to do. It goes against the grain to sell off part of a winning fund that has had double digit returns and switch the money to a seemingly dormant or losing fund.

This may be why almost 60% of the net sales of mutual funds so far in 2017 have been to balanced funds (IFIC) – a combination of equity and fixed income investments.

Popular examples include:

• Mawer Balanced Fund
• Tangerine Balanced Portfolio

The MERs are slightly higher, but the funds are automatically rebalanced which is a plus if you don’t have the emotional discipline to do so yourself.

Final thoughts

Mutual funds are a popular way to build a diverse portfolio because they make investing in the financial markets easy. In some instances, such as a company pension plan, they may be the only choice available to you. They are flexible (easy to buy and sell) and can be purchased in regular small sums with no trading fee, which is an advantage for small portfolios and beginning investors.

Do your research to make sure you are using the best, least expensive funds that are the most appropriate for your personal financial plan.