Understanding Mutual Funds

Access a world of opportunities with mutual funds.

A mutual fund provides investors with access to professionally managed, diversified portfolio of investments for a relatively low price. Each mutual fund is essentially a basket of many different types of investments, including stocks, bonds, T-Bills and other securities. Because money is pooled, investors can gain access to more investment opportunities than they would have on their own.

  • Professional money management – Each fund has a team of Portfolio Managers and Investment Analysts who research and choose the specific investments for the fund.

  • Diversification – Most funds invest in many different kinds of investments so you can get access to opportunities in different industries and sectors, domestically and around the world. Diversification can also help reduce risk in your portfolio.

  • Flexibility – Mutual funds can be held in both non-registered savings plans and registered plans.

Generally speaking, most mutual funds are designed for those looking for longer-term growth potential. Mutual fund values can fluctuate, although not to the extent of investments such as individual stocks or bonds.

As you research different mutual funds, consider the following:

Understand what the mutual fund is created to do
Every mutual fund has its own specific investment objectives. You can get an overview of the mutual fund by reviewing the Fund Fact Sheet created by the fund company. The prospectus, on the other hand, provides a more detailed outline of fund information, investment strategies and objectives as well as other legal details.

Fund Fact information is available on Scotia OnLine® within the mutual fund trading page.

Risk ratings
Standardized risk ratings for mutual funds are assigned by MorningstarTM, who use a mathematical tool to evaluate a fund over a three, five and ten-year period. The risk rating ranges from one to five stars—one star represents the lowest risk and five the highest. This risk rating system is designed to provide investors with a snapshot evaluation of risk and aid investors with fund selection.

Management costs
You should have a thorough understanding of the costs and fees associated with the fund. Generally, there are two central costs to an investor: management expense ratio (MER) and load/sales charges. Learn more about mutual fund fees and sales charges, click here.

Net Asset Value (NAV)
Because mutual funds are baskets of securities, valuating the fund price can be challenging for new investors. The simplest way to determine the price of a mutual fund is by calculating the net asset value (NAV). NAV is essentially the total equity of a fund, calculated as the total fund assets less all fund liabilities. Similar to a stock price, the NAV is typically used as a price for transacting units in a fund. When you buy or sell units of a mutual fund, you usually do so at the price of the NAV, typically calculated at the end of each business day.

Fixed Income Fund
As the name suggests, fixed income funds are mutual funds designed to provide investors with a constant, fixed rate of return. They usually consist of debt-based securities, such as different types of bonds. The rate of return is primarily driven by regular interest earnings which the fund earns from the various constituent bonds.

Certain fixed income funds, like high-yield corporate bond funds, have the potential to provide you with higher returns. But keep in mind that the risks may be higher than with government bond and investment-grade corporate bond funds.

Money Market Fund
Like fixed incomes funds, money market funds invest in fixed income debt-based securities, but are designed as a shorter-term, stable investment option. These funds can consist of government bonds, T-bills and other low-risk investments.

Equity Fund
Equity funds are mutual funds which invest in a basket of equities. There are a variety of different equity funds focused on both Canadian and global equities, as well as specialized growth stocks and sector-specific stocks. Equity funds typically have higher risk profile than money market and fixed income funds, but also have a higher potential for return.

Balanced Fund
Balanced funds invest in both debt and equity-based securities, including fixed income securities and stocks. By investing in different types of securities, balanced funds can hedge higher risk equity investments and reduce the risk of overall losses. Asset allocation is designed around the investment strategy and objective of the fund. More aggressive funds will consist of more equities, while conservative funds will consist of more bonds. Balanced funds are typically higher risk investments than money market funds and fixed income funds, but lower risk than equity funds.

Index Funds
Index funds are funds which strive to track the performance of various stock indices, such as the S&P and TSX Composite. Index funds typically have a lower MER than other mutual funds as they require less professional money management, due to the fact they own all the securities of an index as opposed to a subset.

Fund-of-Funds are mutual funds which invest in other mutual funds. Similar to balanced funds, fund-of-funds aim to diversify investments but differ by diversifying across investment style and philosophy. These funds typically have higher MER than individual mutual funds.

Mutual fund distributions are payments made to an investor from the earnings generated when securities in the fund are bought and sold. Distributions are generally divided into two types, dividends and capital gains. Garnering basic understanding of distributions and applicable taxation is a valuable piece of knowledge for all investors.

Interested in investing in mutual funds?

Log onto Scotia OnLine, go to “Quotes & Research” and click on “Mutual Funds”. There you will find all the investing ideas on mutual funds.

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Read the next article on mutual fund fees and sales charges.