Mutual Fun…ds – Part I

Tis the season! RRSP season that is! If you haven’t heard from your financial planner or investment representative yet, expect a call from them pretty soon. I can only imagine what percentage of their annual business is completed during the first few months as people are rushing to make their RRSP contribution before the deadline (February 29, 2012).

The mutual fund industry has done a brilliant job of advertising and convincing people that Registered Retirement Saving Plans (RRSPs) and mutual funds are one and the same. Remember, RRSPs are an investment VEHICLE that can be filled with different types of investments, such as Exchange Traded Funds (ETFs), Guaranteed Investment Certificates (GICs), mutual funds, bonds, and even good old cash. Ditto with your Tax Free Saving Account (TFSA).  Just because you have RRSPs DOES NOT mean you are limited to just mutual funds.

I think a large percentage of my readers currently own mutual funds. But if I were to ask them what they are, what percentage would be able to answer? Can you tell me what mutual funds are? If you hesitated, don’t feel guilty. I’m sure a lot of people would be stumped; at least they are from my experience. Yet, we are all rushing to throw hundreds or thousands of dollars to invest in them.

What are they?

A mutual fund is essentially a portfolio of stocks and/or bonds. Instead of you going out and buying shares in companies (stock) or bonds (either company bonds or government bonds), mutual funds do that for you. They collect money from a group of people, and in turn, their professional fund manager buys and sells stocks, bonds and other securities based on goals of the fund. As an investor in a mutual fund, you own shares, and this represents a portion of the holdings of the fund.

In Canada, we are fortunate enough to have the largest variety of mutual funds in the world! Unfortunately, we are also subject to some of the highest fees in the world. There are a lot of types of mutual funds you can buy, but they boil down to three main types:

–          Money market: These funds usually consist of short-term debt, such as T-bills. The return is very minimal and it is a relatively safe place to park your money. Notice that I said PARK your money, not INVEST your money.

–          Fixed-income/Bond Funds: The purpose of these funds is to provide income on a steady basis. They invest primarily in either corporate debt or government debt. In other words, you are lending money to companies or the government, and they’ll pay you for it. These funds are riskier than money market funds, especially in a low interest rate environment (which we are currently in). All you need to know is that when interest rates GO UP, bond values will GO DOWN.

–          Equity Funds: Basically funds that hold different stocks. Different funds have different investing goals, which will affect the different types of stocks the fund manager will buy and sell. These are the riskiest types of mutual funds, but also the ones with the potential to provide the most gains.

If you invest with a bank or investment company, they will go through the exercise of figuring out your asset allocation. You will have to sign off on this, which essentially will cover their butts if you lose your money and want to sue them. With this allocation, they will proceed to recommend a portfolio that contains either one (or a collection) of mutual funds. Although it may feel like you are handing your money over to a ‘professional,’ do not blindly trust that they have your best interests at heart. Ultimately, their paycheque and bonuses are based on the volume of products (mutual funds) they can sell. Before purchasing any mutual funds, ask them what the MERs are, and if there are any additional sales charges associated with the recommended funds. As a general rule of thumb, you want to own funds with the LOWEST MERs and do not have any additional sales charges at all. Expect some resistance. After all, higher sales charges = more money for them.

Phew.. there is a lot to say about mutual funds. I want to give you a brief overview, so stay tuned for Part II, where we will go over the advantages and disadvantages of mutual funds, and my favourite types of mutual funds (index funds!). Following this will be some information on Exchange Traded Funds (ETFs) as requested!

Are you going to make a last minute RRSP contribution? Are you planning on investing it in mutual funds?

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