A mutual fund is a method in which money is pooled from multiple individuals to invest in various assets, such as bonds, equities, and money market investments. Fund Managers professionally manage mutual funds, allocating the fund’s assets and maximising returns for investors.
What are the advantages of investing in a mutual fund?
An investor may opt to invest in a mutual fund for various reasons. To mention a few, mutual funds typically have a modest initial commitment requirement. They are traded daily at their closing Net Asset Value (NAV), making them relatively accessible to most investors.
Another advantage of mutual funds is that professionals manage them. For actively managed funds, fund managers analyse market opportunities and other factors to choose which stocks, bonds, and other securities to buy and sell to achieve the mutual fund’s investment objective.
Finally, mutual funds enable investors to diversify their holdings. Because most mutual funds invest in various securities, the risks associated with investing in single securities are decreased, as you are not putting all your eggs in one basket.
What is the distribution process for mutual funds?
Distributions may take the form of capital gains, interest income, or income from foreign sources, together referred to as “taxable dividends.”
Due to the diversification of the assets mutual funds invest, income can be derived from dividends on stocks and interest on bonds kept inside the fund’s portfolio. Typically, a fund will distribute a percentage of the money it earns over the year to fund shareholders. Additionally, if the fund sells appreciated stocks, the majority will distribute the profits to investors.
Finally, if the Net Asset Value (NAV) of a fund improves but the fund manager does not sell it, its units will increase in price. Investors can then profitably sell their mutual fund units on the market.
Generally, distributions are taxable to the investor regardless of whether they are paid in cash or reinvested in the mutual fund.
What method is used to calculate distributions?
Distributions are made to unitholders in proportion to their holdings on a particular day, referred to as the “record date.” Distributions are paid monthly, quarterly, or annual, depending on the fund.
Costs associated with mutual funds
In general, investment in a mutual fund entails fees. Some of these fees are borne by the fund directly, while the customer bears others. It is critical to understand the fees and expenditures associated with the fund and how they will affect your investment in the fund. Important information about the mutual fund can be found in the Fund Facts and Simplified Prospectus.
Typically, mutual fund expenses are stated as a Management Expense Ratio (MER). The MER is calculated as the sum of the fund’s management fee (which includes the trailing commission) and any other expenses, costs, or fees. The MER is not charged directly to investors but is taken from the fund’s returns.
The MER is calculated by adding all of the costs associated with operating the fund. This figure comprises management fees, taxes, and operating expenses. These go to the fund manager to cover the cost of the fund’s day-to-day operations, which include research, regulatory compliance, investment management, and professional management.
Why do MERs differ?
MERs vary according to the type of fund and its level of active management. For instance, index funds typically have lower MERs since they are managed passively, with the fund manager simply matching a market index.
However, with actively managed funds, the fund manager purchases and sells securities to outperform the index. Fund managers, aided by a team of researchers and analysts, are constantly abreast of market opportunities, seeking ways to maximise returns while limiting risk and making investment decisions consistent with the fund’s investment objective.
Actively managed funds, on average, cost more than passively managed funds, as you are paying for investment selection expertise.
Mutual funds vs exchange-traded funds
ETFs are investments that combine the diversification of mutual funds with the trading flexibility of equities. As with mutual funds, ETFs invest in a basket of securities (i.e. a portfolio) such as equities, fixed income, or commodities. Unlike mutual funds, however, ETFs are traded on a stock exchange. As a result, their prices fluctuate throughout the day.
By contrast, mutual fund pricing is established daily after the stock market closes. Additionally, the fund firm processes mutual fund acquisitions and transactions.
How much does an ETF cost?
The expenses associated with ETF ownership include management fees, operational expenses, and trading fees. Like mutual funds, ETFs charge a management fee and incur certain operating expenses related to the ETF’s continuous operation and administration, which may be included in the MER. Additionally, brokerage fees/commissions may apply when purchasing and selling ETFs on a stock exchange.
For additional information, investors should consult the ETF Facts.
How do mutual funds and exchange-traded funds compare in terms of costs?
Cost-conscious investors may be interested in ETFs, which are often passively managed and provide lower yearly fees and no investment minimums. On the other hand, if you desire to invest small sums of money regularly (for example, through a dollar-cost averaging approach or pre-authorised payments), frequent trading costs can diminish your returns, raising the cost of your ETF investment.
Compared to ETFs, mutual funds often require a more considerable minimum investment and have higher operating and management costs. However, it’s critical to remember that those higher costs include active management, which entails the services of a manager who is much more engaged in the selection and management of the funds’ investments and the expense of financial counseling.
If you’re having difficulty deciding between mutual funds and exchange-traded funds based on their investment costs, examine your investing style.
Actively managed funds vs passively managed funds
With actively managed ETFs, the Portfolio Manager purchases and sells securities based on their research and techniques, making tactical and strategic asset allocation decisions based on the fund’s mandate, such as the mix of stocks, fixed income, and so on. They seek to invest in a basket of securities distinct from an index to outperform it to achieve a specific target such as growth, capital preservation, or income. Active management is typically more expensive because of the Portfolio Manager’s expertise, research, and decision-making.
The Portfolio Manager of passively managed ETFs creates a portfolio that closely mirrors a benchmark index. For instance, the ETF would strive to replicate the S&P/TSX Composite Index or the Dow Jones Industrial Average Index (DJAI) by investing in a similar basket of stocks. Passive management is typically less expensive than active management, as less research and skill are necessary to replicate an index.
Which technique is most appropriate for your circumstances?
Active management may be a better fit for investors that meet the following criteria:
- Pursue the possibility of earning a higher rate of return with less risk than a benchmark index.
- Have a defined purpose, such as capital preservation, and wish to capitalise on emerging market prospects
- Desire more access to a broader range of investment strategies, including defensive strategies targeted at mitigating portfolio volatility and risk
Passive management may be a better fit for investors that meet the following criteria:
- Investors that make their investment decision themselves
- Are seeking a low-cost way to gain exposure to a particular investing market
- Are you at ease with the inherent market risk
