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 its 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
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