Mutual Fund industry has been a consistently growing industry, IFIC reported over $500 Billion in mutual fund assets for 2008. Most people are familiar with the term mutual fund and understand it to be an investment vehicle. As the mutual fund industry continues to grow it is vital for investors to get a better understand of mutual funds, the benefits and disadvantages.

What is a Mutual Fund?

Mutual funds are a collection of stocks, bonds and other securities that are owned by a group of investors and managed by experienced fund managers. When you invest in a Mutual Fund you do not own the securities directly you own units in the fund, you become a unitholder. The fund managers invest the money in a variety of securities with the expectation of increasing the fund’s value.

Advantages of Mutual Funds

Mutual funds have some benefits, such as:

  • Built-in Diversification
    One of the key benefits of investing in mutual funds is diversification. Diversification is the most important aspect of a portfolio. A well diversified portfolio can help increase your potential returns and decrease your overall risk. The more varied your portfolio the lower the portfolio volatility.
  • Professional Management
    Many investors lack the time and/or expertise to manage their own investments, mutual funds give you access to a professional fund manager. Access to an experienced, professional fund manager can help save you time, lower your risks and get you where you want to be financially.
  • Liquidity
    You have easy access to your money with mutual funds. You can request that your units be converted into cash at any time.

Disadvantages of Mutual Funds

There are some serious drawbacks with mutual funds

  • Cost
    Costs will be discussed in more detail later on, but cost is probably the biggest downside with mutual funds. The average fee for a Canadian Balanced Fund is about 2.5% annually as your portfolio grows (hopefully) and over time this can cost you tens of thousands of dollars.
  • Index does better
    Most fund managers do NOT beat the index, although some do, you never know ahead which will. Generally your portfolio would perform better if you buy the index and save yourself the management fees.

Cost of Mutual Funds

There are several costs associated with mutual funds, there is the sales charges and the management fees.

Sales Chargesmutual-funds

When you purchase mutual fund generally you will have to pay a commission to the sales representative there are 3 options:

1.       Deferred Sales Charges (DSC) or Back-end Load

This is the most common type of purchase, in this type of purchase you do not pay any upfront commissions. The mutual fund company pays the sales representative on your behalf, however if you sell your units before a certain time you will have to pay commission at that point. Generally this is on a 5-7 year period and the later you sell the lower the fees will be, the sales representative has to disclose this to you. Most companies allow you to take out a certain percentage per year without any fees.

a)      Low-Load

This is the same as the DSC only with a lower “lock-in” period.

Note that in both these structure usually you can transfer within the same fund family without any fees, i.e. same mutual fund company just different fund.

2.       Front Load

This is where you pay the commission directly to the sales representative this is negotiable and usually between 0-6% the higher the amount the lower the percentage will be.

3.       No Load

This is basically fund with no sales fee, most mutual funds are available as No load however not many sales representatives are willing to sell the no load versions. Usually you can get the No Load from the banks, beware you will not be getting any service if you purchase No Load.

Management and other Fees:

You also have to pay the manager a fee for running the fund the more aggressive the fund is the higher the fee will be. Besides management fees you also have to pay transaction fees, taxes and other costs associated with running the fund. Mutual fund companies combine these fees and call it Management Expense Ratio (MER) and it is expressed as a percentage. The fees are taken out of the units and generally the investors does not see these as separate fees on their statements, returns shown for the funds are NET returns, so have taken the fees out.

Different types of mutual funds

There are many different types of mutual funds, with different objectives, risks and rewards to fit each investor profile. The fund manager invests according to the fund’s policies and objectives. Here is a list of the different types of funds, going from most conservative to most aggressive:

  • Mortgage Funds
    Mortgage funds can offer investors a regular income. And because mortgage fund terms are relatively short (five years or less), they are less risky than bond mutual funds.
  • Bond Funds
    Bond mutual funds offer investors competitive returns and a relatively low market risk. The main objective is capital preservation and liquidity; the funds can have gains and losses depending on interest rate movements.
  • Dividend Funds
    The objective is to have tax-advantaged income with potential of capital appreciation. These funds invest in preferred shares and high quality common shares that consistently pay dividends. Income from these funds qualifies for the dividend tax credit, making it an advantage to investors.
  • Balanced Funds
    Balanced mutual funds offer investors a mixture of safety, income and capital appreciation. These funds hold a mix of fixed-income securities and wide variety of common stocks.
  • Equity Funds
    The primary objective of equity mutual funds is capital appreciation, the fund may have dividend income.
  • Specialty Equity Funds
    Some investors feel that some sectors have a potential to outperform the overall markets and would like to diversify into those sectors. These types of funds invest in specialized markets or industries such as natural resources, real estate, science and technology.
  • International Funds
    As investors see more and more opportunities abroad, the international funds continue to gain popularity. International funds offer investors greater portfolio diversification and exposure to stocks on a worldwide, regional and even country basis.

How do I determine the value of a mutual fund unit?

Buying units or shares of a mutual fund is similar to buying shares of a company. Each unit has a specific value that varies from day to day depending on the value of the investments in the fund. The term used to define this value of a mutual fund is Net Asset Value Per Share (NAVPS) and the formula used to calculate the NAVPS of the mutual fund is:

NAVPS = total market value of assets – liabilities
total number of shares (units)

Should I buy Mutual Fund

If you really do not have ANY time/or desire to deal with your investments than yea sure mutual funds could work for you, however just be aware mutual funds can be expensive in the long run. Alternatively you could purchase ETF’s and index funds for much lower cost and probably better returns.



Ray is an ex-financial adviser and the founder of Financial Highway. Currently working in the financial industry and working towards completing his Chartered Financial Analyst, CFA, designation.