What is a Mutual Fund?

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.

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. 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.

Steps to consider before Purchasing a Mutual Fund

1. Have a clear idea of your investment goals and risk tolerance so you can develop your investment strategy wisely.
2. Use Screeners to research the funds.
3. Review the fund's prospectus, which is normally available from the fund company’s website (or at sedar.ca). Make sure the investment objectives of the mutual fund are consistent with yours.
4. Check that the fund has the ability to meet your return expectations in the timeframe you set out, as outlined in the prospectus. Remember that past performance does not guarantee future performance.

Research the past performance of the fund's portfolio manager and compare the fund to other funds or indices of similar asset class or style.