What are they?
A mutual fund is an investment vehicle made up of a collection of stocks and/or bonds. Funds can vary in the amount of returns generated and degree of risk.
All mutual funds are a variety of these three classes:
- Money Market – These are very liquid and are the lowest risk as they invest in short-term government bonds, treasury bills and other money market investment vehicles.
- Fixed Income (mortgages, bonds, preferred shares) – Bonds are riskier but likely to have a higher pay out compared to money market.
- Equity (stocks) – These represent the largest category and invest in corporate shares that bear more risk compared to both bond and money market funds.
How can you earn money?
Generating income from a mutual fund happens in three ways:
- Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
- If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass along these gains to investors as a distribution.
- If the fund holdings increase in price but are not sold by the fund manager, the fund’s units increase in price. You can then sell your mutual fund for a profit.
Mutual funds generally give you a choice between receiving a cheque for distributions or reinvesting your earnings into more mutual fund units.
What are the advantages?
Some advantages when it comes to mutual funds are:
- Professional Investment Management – Portfolio managers will do the research for you and carefully supervise, buy and sell stocks that are right for you.
- Diversification – By owning shares in a mutual fund, you’ll hold many securities therefore your risk is significantly decreased.
- Liquidity – Ability to get in and out with ease.
- Lower Costs– Economies of scale make mutual funds cost-effective. Buying and selling large amounts of securities at a time will make transactions on a larger scale and cost less.
- Simplicity – Working with a Financial Planner will streamline the process and can make suggestions to make investing with mutual funds work for you.