Mutual Funds

Mutual Funds can take many forms, but the common characteristic is that they are not guaranteed.

People usually invest in mutual funds because they want increased flexibility from their investment and they want more potential than what is available from a GIC. Professional money managers manage mutual funds, so that the investor does not need to understand a great deal about investment in order to benefit.

How Mutual Funds Work

When you invest in a mutual fund, your money is pooled with other investors’ money in the fund. You receive units, or shares, in the fund in exchange for the money you invest.

The fund uses the money received from investors to buy investments, which are held in trust on behalf of the investors by a custodian. The custodian must be either a Canadian chartered bank or a large trust company.

Each mutual fund is managed by a professional manager. The fund manager invests the money in a variety of investments, and charges the fund a fee for providing this service.

Different Kinds of Mutual Funds

Mutual funds are classified according to the type of investments they hold. For example:

Equity funds hold shares of companies listed on recognized stock exchanges,
Income funds hold income-producing investments such as bonds, mortgages and preferred shares,
Cash equivalent funds such as money market funds hold short-term investments such as treasury bills and short-term corporate notes, and
Balanced funds and asset allocation funds hold a combination of equity, income and cash equivalent investments.

How the Value of a Mutual Fund Unit is Determined

Each mutual fund is valued on a specific day called the valuation date. Most funds are valued daily, but some are valued weekly. Others, such as real estate funds, are valued monthly or quarterly.

On each valuation date, the fund calculates the market value of all the investments held by the fund, less any liabilities of the fund on that day. The result is divided by the total number of units owned by the fund’s investors.

This calculation yields a result called the Net Asset Value per share or unit, often referred to as the NAV or unit value. The unit value is the amount you pay to buy a unit in a mutual fund.

The unit value for individual mutual funds fluctuates with changing market conditions. These fluctuations in unit value occur as the various investments held by the fund rise or fall in value.

An investor is entitled to redeem, or cash in, units in the mutual fund on any valuation date. When an investor decides to sell units in a mutual fund, the fund itself buys the units back from the investor.

When you redeem your units in a mutual fund, the amount you receive is the unit value at the end of the day on the day your units are redeemed, less any applicable fees shared by the fund.

Where to Find a Mutual Fund's Unit Value

Most mutual funds publish their unit values in the major daily newspapers. You can also get this information from an investment advisor, or directly from the funds.

How to Invest in a Mutual Fund

Almost all funds offer monthly investments plans (often referred to as "PAC" plans). With this type of plan, you invest a specific amount each month. In this way, you make small regular payments which can grow into a sizeable investment over time. If you enter into a contractual plan to purchase mutual funds, be sure to check the details of the plan to understand your obligations.

You can also invest a lump sum in a mutual fund. Many mutual funds require a minimum investment-usually $500—on lump-sum investments.

You can purchase mutual funds from a number of different sources.

How a Mutual Fund Investment Can Grow

You may make money on a mutual fund investment in one or both of these ways:

The investments owned by the mutual fund may earn dividends, interest or capital gains. These earnings may either be paid out to you in cash or be reinvested in the fund, buying you more units in the fund.
The mutual fund’s unit value may increase. This occurs when the total market value of the fund’s investments increases relative to the number of units in the fund. However, you should be aware that the unit value may decrease. If that happens, you may lose money if you sell your investment when the unit price is lower than what you paid for the units. You will realize or trigger gains or losses only when you sell units. As long as you continue to hold your units, the value of those units will fluctuate, depending on the value of the fund’s holdings and overall market conditions.

Mutual Funds Must Follow Basic Rules

In Saskatchewan, mutual funds must comply with the provisions of The Securities Act, 1988.

Mutual funds must be described in a prospectus that has been filed with the Saskatchewan Securities Commission. A copy of the prospectus, which gives investors information about the mutual fund investment, must be provided to the buyer.

Mutual funds may be sold only by salespersons registered by the Commission to sell mutual funds.

Advantages of Investing in Mutual Funds

Professional management. When you invest in a mutual fund, you are buying the services of a fund manager who is experienced in investing money. However, not all fund managers are created equal, so it pays to compare their track records. And keep in mind that good past performance doesn’t guarantee good performance in the future; even good fund managers can make mistakes.

Diversification. Many of the risks associated with investing are reduced when you invest in different companies and industries, and even different markets or countries. Having a wide variety of investments is called diversification. Diversification simply means not putting all your eggs in one basket. When you invest in mutual funds, you can have a diversified portfolio of investments for a modest investment.

Liquidity, or "redeemability". You can usually redeem or cash in your units in a fund quickly and easily. However, when you wish to sell, the fund’s unit value may be lower than what you paid to buy the units. If you redeem your units at such a time, you may lose money on your investment.

Time. It takes less time to manage your mutual fund investments because you don’t have to do the research required to select individual investments, track their performance or perform many of the administrative tasks associated with managing investments; these functions are performed by the fund manager. However, as an investor, you should monitor the performance of the fund itself to ensure the fund is meeting your expectations.

Disadvantages of Investing in Mutual Funds

There are certain risks involved in investing in mutual funds:

Your investment is not guaranteed. Mutual fund investments are not guaranteed by the federal or provincial government or any other institution. The value of the fund is based strictly on market value at any given time. Therefore, you could find yourself in the position of selling your units at less than what you paid for them.

Your investment is not insured. Mutual fund investments are not covered by the Canadian Deposit Insurance Corporation (the CDIC).

Your investment may decrease in value. The value of your investment may decline due to changes in market conditions.

Your rate of return is not fixed. Mutual funds do not pay a fixed rate of return. Their return is based on the market values and performance of the investments held by the fund.,

Objectives and Risk Tolerances

Your reasons for investing may be varied. For example, you may be saving for a down payment on a house, or for a child’s education, or you may be accumulating funds for your retirement. With such overall goals in mind, you may have the following objectives for any particular investment:

to earn investment income to supplement your other income;
to achieve long-term growth;
to ensure the safety of your investment;
to keep a portion of your investments liquid so that you can easily cash them in, either for emergencies or to take advantage of attractive investment opportunities that may arise; or
to maximize after-tax returns, which can be accomplished in a variety of ways.

You may find that you have several investment objectives. Decide which are most important to you, and choose your investments accordingly.

Three basic factors affect your own tolerance for risk:

Time horizon: The amount of time yo have to save for future needs may affect your risk tolerance. For example, since younger people have a longer period to earn back investment losses, they may have more risk tolerance than older people.
Cash requirements: Your cash requirements may affect your risk tolerance. For example, you don’t want to be in the position of having to liquidate your investments when prices are low in order to meet financial needs and commitments.
Emotional factors: Your own emotional response to risk and volatility also affects your risk tolerance. Some people are more comfortable than others with the ups and downs of the market. Others will be tempted to sell their investments when they are not performing well, instead of riding things out. Don’t take on more risk than you are comfortable with.

Different investments have different degrees of risk. When you are choosing investments, choose those with risk levels that match your own tolerance for risk.

The Costs of Investing In, Owning and Selling a Mutual Fund Investment

There are a number of fees and costs associated with mutual fund investments that reduce the return you will receive on your investment.

Determine what services you will receive for the fees you are charged. You may be willing to pay higher fees if this means you will receive a higher level of service and advice.

Commissions: Commissions, or sales charges which you pay to the salesperson who sells mutual fund units, are often referred to as loads. Paying a sales load buys you the salesperson’s service and advice - it does not assure you that the fund will achieve superior returns.

Some mutual funds charge a front-end load, a commission that is applied at the time you invest in the mutual fund. The amount you invest is reduced by the amount of the commission. For example, if you invest $1,000 in a fund which charges a front-end load of $50, the amount that will actually be invested in your mutual fund account is $950.

Some mutual funds charge a back-end load, sometimes called a deferred sales charge or redemption fee. Instead of paying a commission at the time of purchase, you pay a fee if you redeem your units within a stated time period. Redemption fees are reduced—usually to zero—the longer you hold your mutual fund units before selling.

If you are considering buying a fund with a back-end load, there are several things you should watch for:

you may be charged a higher annual management fee than you would pay on a front-end load fund;
you may be charged an annual distribution fee, calculated on the net asset value of your investment; and
different mutual funds calculate their back-end loads in different ways. Some funds base their calculation on the market value of the fund at the time of redemption, whereas others base the calculation on the original price paid for the units.

Some funds are no-load—you pay no commission, either at the time of purchase or when you sell your units. You should be aware that no-load funds may not offer the same level of service as funds that charge commissions. When you buy no-load choices, you generally make your own choices, without the assistance of a financial professional. In addition, you should also be aware that some no-load funds charge a higher management fee than funds that charge commissions.

Management fees: All mutual funds charge management fees, which are paid to the fund manager for managing the fund. Management fees include payment to the fund manager for services such as portfolio selection and advisory services, and may also include a variety of other expenses paid by the fund. Management fees are deducted from the fund’s assets and reduce the return earned by the fund.

The fund may also pay for many operating expenses, such as the cost of preparing and distributing financial statements and other information about the fund. Operating expenses may be included in the management fee or charged separately to the fund. The prospectus will contain full details.

In some cases, the fund will pay trailer fees, also called service fees, to salespersons. Trailer fees are ongoing fees paid to the salesperson as an incentive to continue to provide service to the client.

The various expenses paid by the fund are measured by the management expense ratio, which is disclosed in the fund’s prospectus or financial statements. The management expense ratio, shown as a percentage, is calculated by dividing the total annual expenses of the fund by the fund’s average net asset value over the year.

Other Fees: There are a variety of other miscellaneous fees that you may be charged. The most common of these are:

Set-up fees: You may be charged a fee to open an account with a mutual fund.

Switching fees: Some mutual fund companies allow you to switch from one to another of their funds, but you may have to pay a fee for this.

RRSP/RRIF trustee fees: You may have to pay an annual trustee fee if the mutual fund is held in an RRSP or an RRIF.

Transfer fees or closing fees on registered accounts: You will often pay a charge to transfer a registered account such as an RRSP to another mutual fund group or another financial institution.

Before you invest in a mutual fund, be sure you understand the commissions and other fees you will be charged and that you know the fund’s management expense ratio.

Compare the fee structures and management expense ratios of various funds. When comparing two funds with similar investment objectives and performance records, if one fund charges higher fees than the other, determine what additional service you will receive for the additional fees. Decide whether you are prepared to pay the extra fees to receive these services.