Mutual funds offer financial advisors a simple way to help investors grow wealth. Read this article to help guide your clients with the right choices.
Investing in mutual funds can be overwhelming, especially for people who are new to investing. There is a lot to understand, and it’s common to feel uncertain. Even when your clients have the right information, they might still make the wrong choices.
In this article, Wealth Professional Canada will cover everything you and your clients need to know about mutual funds. We’ll explain what mutual funds are, describe the different types, and highlight important points to think about before investing. We’ll also point out common mistakes to avoid. If you’re wondering whether mutual funds are a good fit for your clients’ investment portfolios, keep reading.
What is a mutual fund?
A mutual fund is an investment product that collects money from many people and uses it to buy a mix of assets. These assets might include stocks, bonds, cash, or a combination of these. When someone invests in a mutual fund, they own units of the fund. Each unit represents a share of everything the fund owns.
Professional portfolio managers are responsible for managing mutual funds. They choose which assets to buy, keep, or sell, depending on the fund’s objectives. For example, a fund focused on increasing in value will likely invest in stocks with a strong growth potential. A fund focused on income will likely invest in bonds that pay regular interest.
This type of investment vehicle also has charges like the Management Expense Ratio (MER). It’s vital for financial advisors to make sure that investors are aware of these costs when building their portfolios.
To better understand how your clients can start investing in mutual funds, watch this video:
If you want to help your clients make good investment choices, take a look at our guide on the top 10 performing mutual funds in Canada.
Which bank is best for mutual funds in Canada?
The best bank for mutual funds depends on factors such as your clients’ financial profile and investment goals. Their tolerance for risk and other preferences should also be considered.
Ask your clients if they prefer dominating players like the Big Five banks in Canada or if they’re interested in smaller ones. Some of these banks might not have huge market capitalizations but they have proven track records.
Types of mutual funds
There are two main types of mutual funds:
- closed-end funds
- open-ended funds
Here’s what you need to know about each:
Closed-end funds
A closed-end fund issues a set number of shares, which are sold to the public through an initial public offering (IPO). After the IPO, these shares are traded on the stock market, just like regular stocks.
The price of closed-end fund shares changes based on supply and demand. Because of this, they often sell for less than the actual value of the fund’s assets.
Open-ended funds
Open-ended funds are the most common type. They do not have a fixed number of shares. When someone invests money in the fund, new shares are created. When someone wants to sell, the fund buys back the shares. The price is based on the current value of the fund’s assets.
When advising clients about mutual funds, remember that you must consider both the type of fund and its fee structure.
Factors to consider when investing
Selecting the right mutual fund is a huge part of building a client’s investment portfolio. As such, try to make sure that the mutual fund matches your clients’ financial plans and comfort with risk.
Encourage your clients to pay attention to these factors when learning to invest in mutual funds:
1. Fund objectives
When learning how to invest in mutual funds, it’s beneficial for your clients to start by looking at the fund’s goal. The fund’s purpose should match their needs.
For example, a younger client saving for retirement might benefit from a fund that focuses on growth. Older clients, on the other hand, might prefer a fund that provides passive income and has lower risk.
2. Level of risk
Every mutual fund will always have some risk, no matter how tiny. Equity funds usually have more ups and downs, while fixed income and money market funds tend to be more stable.
The right level of risk depends on the investor’s age, timeline, and comfort with changes in the market. Knowing how much risk your clients are willing to take will help you narrow down the options.
3. Fees and charges
Mutual funds charge fees for management and operations, and these fees can affect returns over time. Lower fees can help your clients get better results, especially if they plan to invest for a long time. No-load funds, which do not charge sales fees, might be a good choice for some investors.
They should also look at the fund’s Management Expense Ratio (MER) and any sales charges. To learn more about how MER works, watch this video:
4. Fund manager’s performance history
The fund manager’s main job is to allocate assets and try to deliver returns for investors. Clients should check how long the fund manager has been in charge and review the results of their past decisions.
A fund manager with a good history can make a big difference in the success of a mutual fund investment.
5. Diversification and asset mix
A strong mutual fund should invest in a variety of assets. This helps lower risk, because if one investment does poorly, it won’t hurt the whole fund as much.
Ask your clients to make sure their chosen mutual fund adds something different to their portfolio. If the fund is too similar to what they already own, it won’t help with diversification.
6. Tax consequences
Some mutual funds can have a tax impact—for example, capital gains. If your clients are investing in a taxable account, consider how the mutual fund might affect their taxes. You might also want to suggest more tax-efficient funds.
Is a mutual fund a good investment?
Short answer: yes. One reason is that mutual funds are a good choice for long-term investing. They encourage people to stay invested even when markets are uncertain. Many investors find that mutual funds help them reach their financial goals.
Another benefit is that mutual funds are managed by professionals. Clients can also set up automatic contributions, which makes investing easier and less stressful. Other reasons why mutual funds are popular include:
- they have low minimum investment amounts, making it easy to start with small sums
- they offer built-in diversification, which helps reduce the risk of losing money from a single company
- they do not require constant attention, which is good for people who prefer a hands-off approach
- they can be held in registered accounts such as Registered Retirement Savings Plans (RRSPs) and a Tax-Free Savings Accounts (TFSAs)
Are ETFs better than mutual funds?
Both exchange-traded funds (ETFs) and mutual funds give investors access to diversified portfolios, but they are suited to different approaches.
ETFs are better for people who want:
- lower fees
- greater tax efficiency
- more control over buying and selling
ETFs trade like stocks and often follow an index. Mutual funds, on the other hand, are managed by professionals and might be better for people who prefer not to manage their investments daily. The same is true for those who use retirement accounts where frequent trading is not needed.
The right choice depends on your clients’ goals and how involved they want to be in managing their investments. If they want lower fees and the ability to trade during market hours, ETFs might be a better fit. If they want convenience and professional management, mutual funds might be the way to go.
No matter what your clients choose, the best investment is the one that fits their strategy. Advise them to be patient as they wait for their portfolios to grow through profits, returns, or capital gains.
Learn more about ETFs and mutual funds in this article.
Mutual fund investments: Setting your clients’ expectations
Investing in mutual funds can help your clients grow their wealth. However, it’s essential for them to set realistic expectations based on expert advice. Their decisions should be supported by facts. For instance, just because a fund has performed well in the past or has a well-known manager does not guarantee future success. High fees and hidden biases can also lead to poor investment results.
It’s also vital to think about personal values and goals. The best choice depends on your clients’ preferences and financial plans.
Check out more articles about mutual funds and other types of investment vehicles in our Practice Management page.
