What Do I Actually Own When I Buy a Mutual Fund?
By the Inspired Investor teamJune 16, 2023
Here’s a quick rundown on mutual funds – how they work and why they’re popular.
When you pick up a fruit salad at the grocery store, you get a healthy mix of bite-sized chunks. No washing or peeling or chopping required; the fruits are selected, measured and conveniently packaged for you. You can also find different styles of fruit salad, too – tropical, berry, melon – depending on your preference.
Investing in a mutual fund is like buying that fruit salad. A mutual fund pools money from many individual investors to buy a collection of stocks, bonds or other securities. When you invest in a mutual fund, you are buying units in a professionally managed portfolio of securities, with each unit representing a share of ownership in the portfolio. The size of the portion you own depends on how many units you purchase.
Mutual funds are managed by professional portfolio managers who buy and sell the securities in the fund’s portfolio. These managers monitor market conditions and aim to fulfill the mandate of the fund, which can include managing risk, performance and sector exposure.
Why are there so many different mutual funds?
Mutual funds each have their own mandate and strategy, which might include focusing on a specific market sector, region, company size or asset class. A mutual fund may also invest in various asset classes. Some examples are energy or technology, global or Canadian, small companies or large, and fixed-income or equity.
A mutual fund can focus on a narrow corner of the markets or take a broader approach. Just like those fruit salads at the grocery store, there are a lot of options. Because mutual funds hold different investments, they provide investors with a degree of diversification. This can help investors better absorb market fluctuations and avoid the “don’t-put-all-your-eggs-in-one basket” problem. Diversification, along with the ease of purchase, professional management and variety of available options, are reasons why mutual funds are popular among investors.
Many mutual funds are actively managed, meaning the portfolio manager selects securities based on the fund’s stated mandate and the overall goal of outperforming the broader market. Other funds, known as index funds, are passive investments meant to simply mirror a market index, such as the S&P/TSX Composite Index, the benchmark index for Canadian stocks. In either case, the transaction and administration costs of the fund are spread across all of its investors.
How much do mutual funds cost?
It’s important to differentiate between the price of one mutual fund unit and the fees associated with the management and administration of the fund. The price of mutual fund units fluctuates, depending on the value of the investments it holds. The price of these underlying investments changes throughout the trading day, and so the price of one mutual fund unit is revised and posted at the end of each trading day.
There is a fee associated with mutual funds, which covers the cost of trading, operating expenses, taxes and the expertise of the portfolio management team. This fee is called the Management Expense Ratio – commonly referred to as the fund’s MER. It’s expressed as a percentage of the fund’s average net assets. The MER is paid out of the fund before its return is calculated. A fund’s MER is automatically deducted from the fund assets, meaning the return of your fund is calculated after the deduction of such fees.
The MER – usually ranging from 1 to 3 per cent – is always disclosed in the fund’s prospectus and is publicly accessible online. Some funds offer fixed MERs to make the cost of investing more predictable. This means that the MER does not change from year to year. Most mutual funds require a minimum initial investment of roughly $500 or $1,000. From there, you can usually invest in smaller amounts, $25, $50 or $100 at a time.
Mutual funds are generally considered liquid investments, which means you can usually sell your units as the need arises and have your money available within two business days. You receive the price based on the unit value at the end of the day you sell.
Did you know?
The origins of mutual funds can be tracked back to the Netherlands in the 18th century. In 1772, a severe financial crisis in Europe left many small investors bruised. Two years later, an Amsterdam-based businessman named Abraham van Ketwich launched what is now believed to be the first mutual fund, which invested clients’ money in a variety of assets including bank and government bonds.
The name of the that first Dutch fund? Eendragt Maakt Magt, which translates to Unity Creates Strength. Since those early days, the mutual fund industry has prospered in North America and around the world.
Mutual Funds are sold by Royal Mutual Funds Inc. (RMFI). There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Please read the Fund Facts/prospectus before investing. Mutual fund securities are not insured by the Canada Deposit Insurance Corporation. For funds other than money market funds, unit values change frequently. For money market funds, there can be no assurances that a fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in a fund will be returned to you. Past performance may not be repeated. RMFI is licensed as a financial services firm in the province of Quebec.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.