Mutual Funds

The Ten Most Frequently Asked Questions

1. What is an investment fund?

2. Are funds risky?

3. How do the rates of return offered in funds compare with savings accounts?

4. What is the minimum amount of money that I can invest in a mutual fund?

5. How can I compare the rates of return between different groups of funds?

6. How easy is it to sell funds?

7. What types of funds are available?

8. Are funds covered under the Canada Deposit Insurance Corporation?

9. How are funds suitable for young people - and where can one get advice on investing and buying into funds?

10. What does it cost to invest in a fund - and do I need to understand stock, bond or money markets before I invest?

 

1. What is an investment fund?

When you invest in mutual funds you are putting your money together with many other people and asking a professional money manager to invest it on your behalf. The fund manager invests it for the whole group into a variety of investments, which suit the fund's specific investment objectives. Each fund has its own investment objectives. Funds can invest in stocks, bonds, cash or other securities or combinations of these types of securities. If the fund manager's choices of investments make a profit, you share that profit along with everyone else in the group. If the investments lose money, everyone shares in the loss. When you put money into a fund, you receive in exchange units or shares of that fund. A mutual fund's unit value is described as the net asset value per share (NAVPS). The NAVPS is calculated by taking the total value of the fund if everything was sold on that day, less any outstanding debts it owes, and dividing by the number of units held by all the fund's investors. For example, if a fund is worth $10 million (value less what it owes) and has one million units outstanding the NAVPS will be $10. If you own 10 units your investment is worth $100.

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 2. Are funds risky?

Mutual funds have different investment objectives and invest in different types of securities or investments. The element of risk varies depending on the types of investments in the funds. For example, a fund seeking to grow in value over the long term may invest in the stocks of more risky companies. Generally speaking, it can be assumed that the higher the risk, the better the investment should do for you. Risky investments have to pay off for investors or no one would buy them.  However, mutual funds control risk to some extent because they are diversified. That means they invest in a large number of investments at the same time spreading out the impact if any one of the investments should lose money. For example, if the fund held stocks in 30 companies and one company went out of business, the loss of the value of that stock would not make the fund collapse as there are 29 other companies that are still doing fine and growing. You must also realize there is the risk of taking no risk. If you invest in cash, inflation can eat away at your purchasing power. Inflation is how much the cost of goods increases over time. For example, if you hold cash and the cost of goods rises by 3%, the jeans you want to buy will cost you $103 now while you only hold $100.

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3. How do the rates of return offered in funds compare with savings accounts?

When you put money into a savings account you are receiving a very low rate of interest. The bank uses your money to lend to other customers, charging a higher rate of interest. The difference between those two rates is how the bank makes money. The value of your account never goes down and it only goes up with the payment of interest.

The rates of return for mutual funds that hold investments that go up and down in value (such as stocks and bonds) are usually higher than savings accounts. You are being paid back for the risk you are willing to take by investing in a variety of companies. However, remember mutual funds that hold investments that go up and down in value can decrease in value as well as increase - where as savings accounts can never decrease in value.

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4. What is the minimum amount of money that I can invest in a mutual fund?

This varies between funds but the general minimum is about $50 a month or a lump sum of about $500.

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5. How can I compare the rates of return between different groups of funds?

You should only compare funds that have similar objectives. The financial press prints the value of fund units and periodic returns on a regular basis. However, keep in mind that the percentages they print for 1-3-5-10 year returns presume that you made only one investment at the beginning of that period they are reporting on. For example, if on June 30 the fund you are invested in posted a 10% one-year return, your investment will only match that 10% return if you invested exactly one year ago and left the money in there to grow.

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6. How easy is it to sell funds?

Fund companies must buy your fund units back at the value for that day whenever you ask them to. In most cases, you can sell your mutual fund units and receive your cash in a matter of days.

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7. What types of funds are available?

There are three main categories of mutual funds: money market funds, bond funds, and equity funds. There are a variety of types within each category:

Money Market Funds: Money market funds invest in good quality government guaranteed investments with very short time frames. These investments pay interest to investors. They are most appropriate for short term investment and savings goals or in situations where you want to safeguard the value of your investment while still being paid interest. Money market funds have relatively low risk compared to other mutual funds but they also have low returns. However, they do usually pay higher interest than a savings account or short term deposit.

Bond Funds: Bond funds invest primarily in bonds. When you buy a bond, the company selling it to you is promising to pay you your money back on a certain date with interest. Bond funds have a higher risk (especially interest rate risk) than money market funds, but result in higher returns. Unlike money market funds, bond funds are not restricted to investments with short time frames. Some bonds come due in 20 years. There are many different kinds of bond funds and as a result they vary in their risks and returns.

Equity Funds: Equity funds invest primarily in stocks of companies, generally common shares. When you buy a stock of a company you are buying a piece of the ownership of that company. Some equity funds invest strictly in Canadian companies and others may invest in companies in other countries. Equity funds are riskier than money market or bond funds, but they also can offer the highest potential returns. A stock's value can rise and fall quickly over a short period of time, but historically stocks have performed better over the long term than other types of investments, such as bonds and money market instruments. Equity funds are often best used as long term investments.

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8. Are funds covered under the Canada Deposit Insurance Corporation?

The CDIC insures money deposited into a financial institution. Mutual funds are not deposits. Funds promise investors to manage your investment, keep it safely while they have it and to pay you its value when you want it back. There are no guarantees to the value and therefore no insurance. Banks can use your deposits to lend to other people. Mutual fund companies cannot. Because of the government oversight of how mutual funds operate and the rules they must follow, the money you invest is very safe. No one can guarantee protection from market ups and downs, but while your money is invested with the fund company, the regulatory system makes sure it is safe.(For more information see our fact sheet on the protection of mutual funds.)

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9. How are funds suitable for young people - and where can one get advice on investing and buying into funds?

Because of the wide variety of funds available, everyone can find a fund to meet their objectives. Because equity funds have historically had the best performance over the long term, a young person investing for the long term in an equity fund will benefit from the growth of the investment over many years. The longer you have to invest the more your investment will grow.There are a number of different sources of advice on buying mutual funds. Advice can be obtained from mutual fund dealers, financial planners, stock brokers and investment dealers. Mutual funds are also available from some banks, individual fund management companies, trust companies and life insurance companies.

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10. What does it cost to invest in a fund - and do I need to understand stock, bond or money markets before I invest?

As a mutual fund investor, you hire a group of people to manage your money, account for it and keep you informed. You pay their salaries and expenses through various fees.  Some of those fees are paid directly. Others are paid indirectly through deductions from the mutual fund. You'll find all fees - direct and indirect -detailed at the front of the fund's Simplified Prospectus - the document you should receive when you buy mutual funds outlining the fund's goals, objectives, risks, managers and other key information. There are three broad categories of fees: Management expenses (to pay for the management of the fund) Sales fees (to pay for buying or selling the fund's units) Special fees (for special administrative costs)

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For more information or to give suggestions about information you need, contact: The Investment Funds Institute of Canada(416) 363-2158 or 1-888-865-4342