Mutual Fun…ds – Part III

Throughout the series, I hope you picked up a thing or two about what mutual funds are and their advantages and disadvantages. What if I told you that there was a type of mutual fund that combined both the advantages and minimized the inherent disadvantages as well? Would you think I was pulling your leg?

Enter index mutual funds. Save the best for the last, right?

What are they?

As I mentioned before, there is a huge variety of mutual funds out there that you can purchase. The goal of index mutual funds is to essentially replicate the performance of a broad based market index, such as the S&P/TSX Composite Index (stocks traded on the Toronto Stock Exchange). You can purchase index mutual funds for a variety of different markets, including US markets, international markets, as well as bond markets.

Why buy index mutual funds?

Since they are still mutual funds, you still receive the benefits of diversification, cheaper transaction costs and relatively high liquidity. The key is the professional management aspect. You still have a fund manager handling your portfolio for you, but instead of buying and selling stocks that they BELIEVE will BEAT the market at the end of the year, their goal is instead to REPLICATE the market return. If most managers can’t beat the market year over year, why not just accept the market return year after year? As a result, the MERs of index mutual funds are much lower than the average MERs for mutual funds available in Canada. Lower costs = more money in your portfolio. Indexing for the WIN!

Now what?

That’s all fine and dandy. Lots of information. Information overload to some. But let’s say I’ve convinced you to consider index mutual funds. At the VERY least, convinced you to dig up your mutual fund statements and figure out how much you are paying each year (based on your MER). So how does one get started in this wonderful world of indexing?

Full disclosure: when I recommend products, I personally use the products before recommending them. I DO NOT personally own any TD e-series products, but I would highly recommend them as an alternative to any mutual funds recommended by financial/investment advisors. Remember, these people are going to recommend mutual funds that carry higher MERs and possibly additional sales charges to you. Why? Because their livelihood depends on it. How much money am I making on my recommendations? How much was that again? Oh, right, NOTHING! Except the satisfaction of knowing that you’re not getting ripped off.

Anyways, if you already have a mutual fund account with TD Bank, this should be a bit easier.  It is recommended that you actually open a TD Waterhouse Discount Brokerage Account, and from there, you have the option to purchase the e-series funds. With a brokerage account, you can purchase stocks and ETFs as well. When you are setting up your accounts, make sure you understand what the fees are associated with the accounts (ie, one free TFSA withdrawal a year etc.) and watch out for fees for paper billing. They will still try to get money from you in some shape or form.

Once your accounts are set up and funded, then what? How do you choose what to invest in? Determine your asset allocation and choose the corresponding funds. Since I am 30, I will have 30% in bonds.

30% Canadian bonds – TDB 909 (MER of 0.51% as of June 30, 2011)

24% Canadian equities – TDB 900 (MER of 0.33% as of June 30, 2011)

23% US equities – TDB 902 (MER of 0.35% as of June 30, 2011)

23% International equities – TDB 905 (MER of 0.53% as of June 30, 2011)

Assuming your portfolio allocation is IDENTICAL to your ideal asset allocation, your portfolios’ MER is approximately 0.435% a year. Compare this to the average mutual fund in Canada which boasts an average MER of 2.50%. You are saving yourself almost 2% every year! Add in the magic of compounding

Anyways, like I mentioned before, I personally have not gone through the exercise of purchasing TD e-series funds. If you have, please share your experience and any lessons learned. Any additional information will help!

What do you think? Do you now have a better idea of what mutual funds are? ETFs are coming up next!

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Mutual Fun…ds – Part II

In Part I, we went through mutual fund basics; what they are, the different types, and what to keep in mind when certain mutual funds are being recommended to you by your friendly neighbourhood financial adviser or investment professional.

So why buy mutual funds in the first place?

–          Diversification is the main advantage. If you do not have the time (or desire) to research individual stocks and bonds, owning a mutual fund gives you exposure to a large number of them. Therefore, the inherent risk in owning shares in a company is spread out. In other words, if a company goes out of business, the impact on your mutual fund portfolio would be less than if your portfolio consisted of just shares in that company. Mutual funds also give you the opportunity to own a lot more than you would normally be able to do the amount of cash you have invested. i.e. All I want for Christmas is ONE share of Berkshire Hathaway – all yours for the low, current price of $117, 925.

–          Transaction Cost Savings – because mutual funds trade in larger volumes, their transaction costs would be cheaper than what it would be if you bought the stocks yourself.

–          Liquidity – for the most part, mutual fund shares should be pretty easy to sell which will then be converted to cash.

–          Simplicity – just hop on over to your nearest bank, investment or insurance company and they will be MORE THAN happy to sell you some of their products. You can make lump sum purchases or set up automatic purchases every month.

–          Professional Management – TECHNICALLY this is an advantage. It is probably the main advantage that your financial planner/adviser will tell you. Come on, you have a PROFESSIONAL investment manager handling your portfolio for you! Unfortunately, there has been no statistical data proving that actively managed funds perform better than the stock market on a long term basis. Every year, there are managers who do achieve returns higher than the market, but very seldom can they consistently do it year after year. So I will, very grudgingly, add it as an advantage. Cause it is… sorta. Not really. But I digress.

So what are the disadvantages?

–          Professional Management – So I kind of cheated. 🙂 Like I mentioned before, there is no statistical proof that actively managed mutual funds perform better than the market itself. If it was, then everyone who has mutual funds should be RICH! Ya, right. You know who is though? The mutual fund managers and companies. Why is that? When we MAKE money on our mutual funds, they MAKE money. When we LOSE money, they still MAKE money. Something wrong with this picture?

–          Costs – mutual funds aren’t cheap! They are, after all, a product. Not only do you have to pay for the professional fund management, you also have to pay for all the shiny advertising material that you receive when you first purchase the mutual fund. You also pay for someone to keep track of how many shares you own. Oh, and that friendly neighbourhood financial planner of yours? Yup, you are also paying them for selling you the mutual fund in the first place.

–          Taxes – if you are purchasing mutual funds in your RRSPs, then this isn’t an issue. If you are holding mutual funds in a non-registered account, you have to be aware of the tax implications! When the fund manager sells a security, it may trigger a capital gain. These gains are then passed on to the investors, who bear the responsibility of paying for the taxes associated with it.

Like I said, there is a lot to learn about mutual funds. So a question that may follow all this juicy information would be: so, what mutual funds do you own? Er, well, like I mentioned before, I don’t personally own mutual funds. BUT, that doesn’t mean I wouldn’t recommend them. Stay tuned for Part III in the series where I will delve into the world of index mutual funds! I will show you how you can make the most of the advantages that are provided by mutual funds, while limiting the inherent disadvantages as well. All for the low price of… kidding!

What do you think? More info than you ever wanted to know about mutual funds? 🙂

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?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!