A mutual fund is a pool of investments in stocks, bonds or other
securities funded by individual investors who own units of the fund. A
mutual fund’s strategy may focus on a specific sector, region or asset
class, or may invest in various asset classes. Because a mutual fund holds
multiple investments, it provides a degree of diversification. Mutual funds are managed by portfolio managers who buy and sell the securities in the fund’s portfolio and monitor market conditions.
Many funds are actively managed, meaning that the portfolio manager selects securities according to his or her investment philosophy and judgment in an attempt to outperform the market. Other funds, known as index funds, are passive investments that attempt to simply mirror a market index, such as the S&P/TSX Composite Index of Canadian stocks. In either case, the transaction and administration costs of the fund are spread among all of its investors.
Mutual funds are not listed for continuous trading and pricing on a stock
exchange. Instead, mutual fund companies sell their own shares (or units)
to investors and buy back their shares when investors redeem them. New
shares may be issued if investor demand exceeds redemptions.
Purchasing Mutual Funds
You may be aware that commission is paid when buying and selling stock
since they are listed on a stock exchange.
How Much Do I Need to Invest?
Most mutual funds require a minimum initial investment of $500 or $1,000.
Subsequent investment amounts are often $50, $100 or $500.
How Are Mutual Funds Priced?
The value of a mutual fund varies from day to day, depending on the value
of the investments it holds. When you buy or sell shares of a mutual fund,
the price is based on its net asset value per share (NAVPS). NAVPS = Total market value of assets less liabilities / Total number of shares (units) outstanding. Most mutual funds calculate their NAVPS daily, while others calculate their NAVPS weekly or monthly.
What Is a Management Expense Ratio?
The management expense ratio (MER) expresses a mutual fund’s annual
fees and operating expenses as a percentage of the fund’s average net
assets. Mutual funds typically pay a management fee (which includes sales
commissions and payment to the portfolio manager) as well as administrative costs and other operating expenses. These fees are paid out of the fund before its return is calculated, so they are an indirect cost for investors. The MER is disclosed in the fund’s prospectus and usually ranges from 1% to 3%. 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.
The Impact of the MER
Many investors highly value the professional management of mutual funds,
and consider mutual funds a cost-efficient way to invest. However, in the
long run, the accumulated cost of the MER can have a significant effect on your portfolio. Reducing the MER where possible can help to improve long-
term portfolio performance. Keep in mind, however, that the quality of management differs from fund to fund. Evaluating a fund based solely on its MER will give you only part of the picture. When you buy shares of a mutual fund, you may pay a sales fee or commission. Details of these charges can be found in the mutual fund’s prospectus.
- No-load: You pay no commission or sales charge.
- Front-end load or initial sales charge (ISC): Investors pay a
commission or sales fee at the time of their purchase, as set out in
the mutual fund’s prospectus. At RBC Direct Investing, however, you
pay no fee to buy a front-end load fund. - Back-end load or deferred sales charge (DSC): You pay a fee when
you sell the mutual fund if you sell within a certain number of years –
usually seven. The fee is a percentage that usually decreases yearly
until it drops to zero. - Low-load: As with a back-end load, you pay a fee only if you sell
within a certain number of years, typically three to four. The
percentage fee decreases over time until it falls to zero.