Mutual Funds
Mutual Funds have traditionally been the most common type of investment purchased by average people (like you and me). That’s because investing on your own was never really an option before the rise of online banking and modern investing platforms.
There are 2 types of Mutual Funds. When you hear people refer to Mutual Funds, they’re most often talking about actively-managed Mutual Funds. For the sake of simplicity, we will be using the term ‘Mutual Fund’ to refer specifically to these actively-managed Mutual Funds.
A Mutual Fund is simply a pool of money from investors, with the investors being the people who buy the Mutual Funds (like you or me). Each Mutual Fund is managed by a group of people, called the fund managers, who decide which stocks and bonds to invest the pool of money in. To purchase a Mutual Fund, you can buy it directly from the company who owns it, or through a “Financial Advisor” at an investment brokerage. Note that more than 90% of Canadian Financial Advisors are simply sales people working for banks or Mutual Funds, and they are not licensed to provide meaningful financial advice.
The goal of actively-managed Mutual Funds is to beat the returns of the broader stock market. To accomplish this, they have a team of people who are constantly monitoring the financial performance of companies and spend a lot of time adjusting which stocks are inside the mutual fund to try to beat the performance of the market. There’s also a lot of marketing and advertising associated with these actively-managed mutual funds to entice people to buy them.
In order to pay for this team of people to run an actively-managed Mutual Fund, as well as the fees associated with buying and selling stocks and bonds so frequently, they charge a fairly hefty fee of 1-2%. Now you might be thinking this fee sounds low, but that’s because the way that it’s presented is misleading. This management fee isn’t charged just once, no, it’s charged again and again and again.
Let’s say you invest $500 per month in a mutual fund with a 2% fee that averages an 8% return (a fairly typical return for an all-stock Mutual Fund). In 30 years your investments will be worth $502,810, but you will have lost out on $231,265 due to the management fees they charged for the Mutual Fund. If you had instead invested with a lower-fee alternative, you’d get to keep some or all of that extra money.
Aside from the ongoing management fee, most mutual funds will charge you additional sales fees when you add and/or withdraw money from the account.
Oh, and spoiler alert: it is incredibly rare to find an actively-managed mutual fund that consistently beats the market year after year. So while you might make a bit of extra money every once in a while, you’ll end up having to pay high management fees even when it performs the same as the market or when it performs worse than the market.
Again, mutual funds aren’t bad by any means- they’re just very expensive! If you have money currently in a mutual fund and you want to avoid the high fees, you have a couple of options. You can request your money be transferred out of mutual funds into a lower-cost alternative (there are fees for doing this but typically the amount you’ll earn in a lower-cost alternative will far exceed those fees in the long-run). You can also just withdraw the money, however there may be tax implications to doing so (we’ll dive more into this later). Alternatively, you can choose to leave your money there and start putting any additional money into lower-cost alternatives. That way at least any additional money you invest won’t have crazy high fees.
At the beginning of this section we mentioned that there are 2 different types of Mutual Funds, but so far we’ve only touched on actively managed Mutual Funds. The other type of Mutual Fund is called a passively-managed Mutual Fund, but it is more commonly referred to as an Index Fund. Index Funds are quite different from actively-managed Mutual Funds, and since they’re so similar to another type of investment called an ETF (more about this below), we’re going to cover Index Funds in that section instead.
Pros:
Completely hands-free: you simply transfer money into the account and it’s invested on your behalf
You don’t need to do anything if the markets go up or down- the fund takes cares of adjusting the investments inside as the economy and the world changes
Most often they are set up through a human “Financial Advisor” who is able to answer any questions you might have about the investments in the Mutual Fund.
Since Mutual Funds invest in so many different stocks and bonds, this diversity of the investments in general makes them less risky than purchasing individual stocks/bonds.
You typically have the option to customize what your money is invested in as much as you’d like (example you could request more money be put in the technology industry)
Cons:
Very high Management Fees that will eat away at your retirement fund
Several other fees that may or may not be hidden
Similar performance and risk-level to newer lower-cost investing options
