Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by a professional fund manager.
It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV.
What are the various types of funds?
Various types of Mutual Funds exist to cater to different needs of different people. Largely, they are of three types.
Money market funds
These funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds. Canadian money market funds try to keep their net asset value (NAV) stable at $10 per security.
2. Fixed income funds
These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds.
3. Equity funds
These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay large dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.
- These invest predominantly in equities i.e. shares of companies
- The primary objective is wealth creation or capital appreciation.
- They have the potential to generate higher return and are best for long term investments.
- Examples would be
- “Large Cap” funds which invest predominantly in companies that run large established business
- “Mid Cap” funds which invest in mid-sized companies.
- “Small Cap” funds that invest in small sized companies
- “Multi Cap” funds that invest in a mix of large, mid and small sized companies.
- “Sector” funds that invest in companies that are related to one type of business. For e.g. Technology funds that invest only in technology companies
- “Thematic” funds that invest
4. Balanced funds
These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer bonds, while conservative funds hold fewer equities relative to bonds.
5. Index funds
These funds aim to track the performance of a specific index such as the S&P/TSX Composite Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.
ACTIVE VS PASSIVE MANAGEMENT
Active management means that the portfolio manager buys and sells investments, attempting to outperform the return of the overall market or another identified benchmark. Passive management involves buying a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.
6. Specialty funds
These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental stewardship, human rights and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons and the military.
7. Fund-of-funds
These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor. The MER for fund-of-funds tend to be higher than stand-alone mutual funds.
Before you invest, understand the fund’s investment goals and make sure you are comfortable with the level of risk. Even if two funds are of the same type, their risk and return characteristics may not be identical. Learn more about how mutual funds work. You may also want to speak with a financial advisor to help you decide which types of funds best meet your needs
What are the benefits of investing in Mutual Funds?
Many of us dread the thought of managing our own investments. With a professional fund management company, people are put in charge of various functions based on their education, experience and skills.
As an investor, you can either manage your finances yourself, or hire a professional firm. You opt for the latter when:
- You do not know how to do the job best – many of us hire someone to file our income tax returns, or almost all of us get an architect to do our house.
- You do not have enough time or inclination. It’s like hiring drivers even though we know how to drive.
- When you are likely to save money by outsourcing the job instead of doing it yourself. Like going on a journey driving your own vehicle is far costlier
How do I know which fund is right for YOU?
Before you invest, take an advisor’s help to understand your :
Investment objectives, Ideal investment period, Risk Appetite
Once an investor has decided to invest in Mutual Funds, he has to make a decision of which scheme to invest in – Fixed Income, Equity or Balanced and which Asset Management Company (AMC) to invest with?
Firstly, discuss freely with your advisor what your objective is, what time period you’re comfortable with, and what your risk appetite is.
Decisions on which fund to invest in would be made based on this information.
- If you have a long term objective – say, retirement planning, and are willing to assume some risk, then an Equity or Balanced Fund would be ideal.
- If you have a very short term objective – say, money to be kept aside for a couple of months; a Liquid Fund would be ideal.
- If the idea is to generate regular income, then
Different types of mutual fund schemes
As per Maturity Period : open ended and close ended
As per investment objective : Equity, debts , Hybrid, Solution based, other schemes
As per Risk appetite : Low , Moderate & High