Although mutual funds have been around since the 1920s, it was not until the declining interest rates of the 1990s happened that sales really took off. Fuelled by this growing demand, mutual fund companies searched the world seeking new investment opportunities. Mutual funds had become-in Hollywood jargon-a "hot property," with everyone rushing to get a piece of the action. Mutual fund companies in Canada now manage over 170 billion investment dollars.
It should come as no surprise that these same companies spend millions of dollars advertising their funds to ensure their market share of your investment dollars. Along with their glossy fund brochures, most of these companies also include equally glossy information kits aimed at educating potential customers about the ins and outs of investing in mutual funds.
Yet with all this information readily available, many Canadians still don't fully understand what mutual funds are, how they work, or which ones-if any-they should invest in. This puts investors in a very vulnerable position. Do you invest in something you don't understand? Do you rely on the advice of a professional? Do you throw up your hands in frustration and stay with CISs and Canada Savings Bonds? Whatever you decide, nagging doubts often remain.
There is no doubt that mutual funds can offer big investment opportunities for small amounts of money-in some cases as little as $25 a month. In order to take full advantage of these opportunities, however, you must know enough to ask the right questions and understand the answers. While there are many books available on investing in mutual funds, most of those books assume a certain level of expertise on the part of the reader. The aim of Ranga Chand's Getting Started witih Mutual Funds is to make investors and would-be investors aware of the basics and give them the knowledge and confidence to invest successfully in mutual funds. So let's take a look at mutual funds together and find some simple answers to all the important questions. But, before we start, let's get one thing straight: you don't have to spend hours every week poring over the business section of the newspaper, or have a flair for mathematics to understand and invest successfully in mutual funds. All you need is some common sense and a little time and effort. Remember, no one has a deeper interest in your financial future than you.
In the past, many of us relied on savings accounts, Guaranteed Investment Certificates, and Canada Savings Bonds in order to put something aside for a home, our children's education, our retirement, or that proverbial rainy day. Although we were at the mercy of prevailing interest rates, "investing" was too complicated, too time-consuming, or something only the wealthy could afford.
Today, people's attitudes have changed. Massive restructuring in the economy, with its inevitable job losses and wage freezes, and uncertainties over our financial future, including lingering doubts about the continued availability of government and company pension plans, have made us all look more closely at how we can get the best return on our money. This search has led us, rightly or wrongly, in unprecedented numbers to mutual funds. Rightly, because many mutual funds do offer excellent opportunities to help us achieve our financial goals. Wrongly, because many people have unrealistic expectations or unknowingly invest in poor performers. But for investors who take the time to do a little homework, mutual funds offer the following key benefits.
This simply means holding a wide variety of investments. In other words, don't put all your eggs in one basket.
Let's assume you have $1,000 to invest. The most you can hope to purchase as an individual investor is a small number of stocks. By holding a stock, you own a share in a corporation's earnings and assets -- anything the corporation owns. Even if the company performs well and your shares increase in value, your transaction costs -- the money you pay your broker to buy and sell the stocks -- will eat into, or maybe even wipe out, any profit you might make. If the company does badly and your shares decrease in value, you will lose money.
If, however, you put that same amount of money in a mutual fund that invests in stocks, you get diversification by the truckload. Your mutual fund may hold stocks in anywhere from fifty to over a hundred companies and in many different industries such as automobiles, pharmaceuticals, and banking. Now, if one of the fund's stocks does badly, the others may still do well. Spreading your money in this way among many different companies and industries effectively reduces your risk -- the possibility that you may lose money. This diversification is one of the biggest advantages of mutual funds.
For most of us, the amount of disposable income and investment knowledge required to accomplish similar diversification would be mind-boggling. Also, sharing expenses with millions of like-minded investors, through a mutual fund, significantly reduces your investment cost. Because a mutual fund combines the assets it holds in trust for you and other investors, it is known as an "institutional trader" and as such can buy securities at wholesale prices. Bulk shopping, investment style! That's not something you and I could ever do, but certainly something we can benefit from.
Mutual funds are run by either an individual manager or a team of professionals who generally bring relevant academic qualifications and years of experience in analysing data, choosing securities to meet the fund's objectives, and deciding when to trade the holdings. That would be an overwhelming task if you were to attempt it on your own. By investing in a well-managed mutual fund, you share the expense of hiring someone with a proven track record. Your $1,000 will receive the same careful attention, and get the same returns, as the money of the institutional investors, such as pension funds, who place billions of dollars a year. It is extremely important to keep in mind, however, that fund managers, like hockey coaches, are not all equal. Some are much better than others.
For many people, the attraction of mutual funds is the possibility of higher returns on their investment dollar. This is especially true during periods of low interest rates. Investors should not assume, however, that all mutual funds will provide these higher returns. While many do, some don't. Of the 1,200 mutual funds currently available, over 130 have consistently delivered above-average returns in their respective categories (see Ranga Chand's World of Mutual Funds for details). A clear indication that many funds do achieve their investment objectives.
Too many funds, however, fall far short of attaining their stated goals. There are an astonishing 149 mutual funds that have consistently posted below-average returns over the past one-, three-, and five-year periods, and some funds, believe it or not, have underperformed for over ten years.
Although past performance is no guarantee of how a fund will perform in the future, it is doubtful whether any investor would knowingly put his or her money into a fund that has consistently underperformed compared to similar funds. Chapter 18 (Doing Your Homework) shows you how to avoid these underperformers and zero in on above-average funds.
Buying a mutual fund is not complicated and can be done in person, by telephone, or by mail. Most mutual fund groups also offer toll-free telephone assistance if you need additional information or help in filling out the forms. You may prefer speaking with someone in person and having them complete the necessary paperwork. Who you finally sit down with will depend on the funds you have selected. This could be the mutual fund salesperson at your bank or trust company, your broker or financial planner, or in some cases your insurance representative. We'll discuss more about who sells what in Chapter 2.
Mutual funds are extremely liquid. This means that it is easy to get at your money if you need it. It is not as quick as withdrawing money from your bank account, however. Units can be redeemed (sold back to the fund) at any time, and your money will generally be available by the next business day or, at the latest, within five business days. Some real-estate funds may take longer. To redeem any or all of your units in a mutual fund, you merely fill in the necessary forms provided by the company. If you need any help, simply call the company's toll-free number. Some companies may require a letter of redemption with your signature verified by your bank or trust company. After the mutual fund company receives the authorization, your money will be either sent to you in the form of a cheque or deposited directly into your bank account. Some companies also allow redemption by telephone or fax, provided you authorize this when you initially buy units in the fund.
The usual minimum initial investment for a mutual fund is $500, with subsequent investments starting at $25. Some mutual fund companies, however, now allow initial investments as low as $25 provided you invest on a regular basis through a pre-authorized investment plan This means you agree to invest $25 or more at specified periods during the year. For example, you can decide on $25 every two weeks or $100 every month. The amount and the frequency depend on the options offered by the company. Once you have decided, this money will be automatically withdrawn from your chequing account on the specified dates. For those on a limited budget or with poor savings habits, this is a good way to start building towards future financial objectives. By investing the minimum $25 a month over a thirty-year period and given an average annual rate of return of 10%, you can accumulate nearly $57,000. If, however, you increase your savings period to forty-five years, that amount grows to roughly $265,000. That's over a quarter of a million dollars from a total investment of $13,500. Not bad for a non-saver on a limited budget!
Along with investing, unfortunately, comes the task of maintaining records. This is where mutual funds can take a load off your shoulders. All mutual fund companies provide unitholders with regular statements detailing all transactions, income earned, and the total value of all funds held. Moreover, when you buy or sell units in a mutual fund, you automatically receive written confirmation. If, however, you expect to receive a cross between a share certificate and a Canada Savings Bond certificate when you buy units in a mutual fund, you are going to be disappointed. The only notification you will receive is a very ordinary looking typewritten confirmation detailing the number of units involved, the price, and the date of the transaction. Some fund companies do issue share certificates as evidence of ownership for a small fee.
Unitholders also receive yearly statements detailing the tax status of all earnings from the fund, including dividends and capital-gains information. The fund company issues either a T3 or a T5 slip for tax purposes, listing the type and amount of income you must report on your income-tax return. It is important to keep these papers in a safe place -- perhaps in a large envelope or file for each fund you own units in. Of course, if your mutual funds are sheltered in a registered savings plan (RSP), you don't have to worry about paying taxes until you withdraw your money You will also receive periodic reports giving information about the status of the fund, its investments, and any proposed changes. All you have to do is spend a few minutes reading the material. (See Chapter 20 for tips on how to stay on top.)
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