What is a Mutual Fund? Explained Here

Posted on February 10, 2021

Some 70% of Canadians believe they might not be saving enough money for their future retirement. Many believe they will need close to $700,000 to live during their retirement years. 

Most recognize the importance of saving for the future. Yet, as people face day to day life challenges, those become a priority, preventing them from saving.

You might be wondering what avenues you can use to increase your savings. You've probably heard many people discussing mutual funds but don't know enough about them to know if they are right for you. Are you wondering what is a mutual fund and how it could help your investment plan?

Mutual funds can be an important long term investment tool to save for the future. Working with a financial advisor can help you understand more about mutual funds, how to use them to make money on your money, and grow your wealth. 

Read on to learn more about mutual funds and whether they should be a part of your investment strategy for saving for the future.

What Is a Mutual Fund?

Before you can know if it will work for you, it's important to understand the concept of mutual funds. You might have heard someone tell you about the importance of diversifying in investing. Put another way, you might have heard the old adage, don't put all your eggs in one basket. 

Both of these suggest that you want your money to be in a variety of places so if there is a dip in one, you have a cushion in other areas. The average investor doesn't have enough real capital to diversify on their own. 

This is where the mutual funds are helpful. A mutual fund is a group of investments brought together under one fund. A mutual fund may have money invested in stocks, government bonds, and securities. 

A mutual fund allows you to invest your money with lower risk than buying stocks, bonds, or securities individually. In Canada alone, there are thousands of different mutual funds available for investors. 

How Does a Mutual Fund Work?

Basically, as an investor, you can buy shares of a mutual fund. Based on the performance of the mutual fund's investment, your shares rise or drop in value.

To buy into a mutual fund you need to know its net asset value or NAV which is determined at the close of the market each day. 

The other thing to understand about mutual funds is that they are often actively managed which will impact the costs associated with buying into them. 

There are also passively managed funds, which are generally more popular and less costly for investors. Passively managed funds have a set investment strategy which is followed using the indeces of the market. 

Because passive mutual funds require much less maintenance by the management team, they are generally less costly for investors.

In actively managed funds, the managers are always working to juggle investments, trying to find ways to potentially outperform the market. This more active management means such type of mutual fund is more costly. 

Types of Mutual Funds

There are a variety of different types of mutual funds. Some mutual funds might focus just on stocks for their investing or just on bonds. While other mutual funds will diversify more and have a variety of investments.

Stock equity funds are mutual funds that carry their investments in stocks. They create more risk for the investor because of the fluctuation in the market. Yet, they also provide more opportunities to make money. With fluctuations in the market, the returns you get from the mutual fund can be impacted, both in a good and a bad way. 

Bond funds, sometimes called fixed-income funds, are less risky than stock funds. Bonds don't have the same level of fluctuation you might see in the market. 

A balanced fund is a mix of the previous types. It makes investments in stocks, bonds, and other securities. Sometimes these types of funds are called asset allocation funds or hybrid funds. One mutual fund might invest into the portfolio of another balanced mutual fund. 

Another type of balanced fund is called a target-date fund. This type of funds has a target date set ahead for when you might aim to retire. As you get closer to that date, it will automatically move your funds into less risky investments so you lower your risk exposure.

As people near retirement, many will place their money in money market funds. These have a lower risk threshold making it a smart investment for that stage in life. They invest in short term-low risk investments to keep your money safer. 

Benefits of Investing in Mutual Funds

The reason so many people choose mutual funds for saving and growing their wealth is because of the many benefits they offer to investors. 

For many people, the world of investing is intimidating and full of fear. You don't want to goof things up on your own. The simplicity that mutual funds offer are a remedy to that. You work with your financial advisor to find a good mutual fund, then you let the experts do their thing. 

If a fund has a proven track record, you can confidently let the managers do the investing work for you.

Another benefit is knowing your money is being managed by professionals in the world of finance on a daily basis. Mutual fund managers are constantly evaluating the investments of the fund to make sure it is reaching its goals.

Mutual funds are affordable to invest in. Many fund managers might even waive minimums. This allows you to get your money into a fund so that it can start to grow over time, even if you don't have a lot of it to get started.

Mutual funds are also more liquid than the money you might have in other assets. Your home might be worth significantly more than your mutual fund investment. Yet, it isn't a very liquid asset, should you find you need access to some money. While it's not usually recommended, if needed, you could sell some shares to get access to funds from a mutual fund.

As previously mentioned, one of the biggest benefits is that mutual funds offer investors the chance to diversify their investment with a single purchase. 

Potential Negatives of Mutual Funds

If you're a bit of a control freak, the idea of someone else managing your funds might make you nervous. And because someone else is managing your fund, you need to pay them. Additionally, some funds may have withdrawal restrictions, making them a less liquid investment. 

Mutual Funds for Retirement

Mutual funds are a smart investment for retirement savings. They offer you the security that comes with diversifying.  

Earlier we mention target date mutual funds that use a sliding scale for risks. As you get closer and closer to retirement, the account reduces the investment risk you are taking. If you know your target date for retirement, the fund will use it to establish your level of investment risk. 

Steps for Buying Mutual Funds

If you want to invest in mutual funds there are some steps you should consider. These are all smart steps to also discuss with a financial advisor as well, if you're taking that route. 

First, you need to decide if you want to invest in a passively or actively managed mutual fund, or in several different ones. 

You want to have a budget in mind for investing. Different funds will require different minimum amounts to get into the fund. As you consider your budget, then you also want to consider the fees associated with investing in certain funds. You'll also need to decide on a broker to make the investment. Often a financial advisor has this in place for their clients. 

Then it's a matter of monitoring your investments and deciding where you need adjustments as you move along and grow your savings.

Understanding Mutual Funds for Your Investments

Understanding what is a mutual fund and how it works can provide more confidence that they are the right investment tool for you. The fact that they help you to diversify your investments and let you make decisions about how much risk you are comfortable with, makes mutual funds a good choice for many investors. 

For more financial planning advice, including addressing your insurance needs, we can help. Contact us today to get a quote and talk about your insurance needs for the future.

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