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How do Mutual Funds Work?

By October 7, 2019 October 9th, 2019 No Comments

There are a lot of different fees and misconception out there today around this topic, so hopefully we can educate you a bit and uncover the truth about mutual funds.

If this is something that’s top of mind for you, and you’re wondering whether you should have mutual funds or not in your portfolio, simply go to speaktorob.com to book a free, no obligation consultation to give you some peace of mind and get you sleeping at night again.

What are Mutual Funds?

Mutual funds, as you potentially know, are actually pooled investments structured through a trust unit. The companies that offer these funds offer shares of the trust unit, which is a pooled aggregation of the multiple different stocks usually or bonds in the fund.

Think of a fund that’s called a Canadian dividend fund. That fund will likely have a whole bunch of different Canadian dividend paying securities. It’ll have insurance companies, banks, telecommunication companies, it might even have consumer discretionary and consumer staples. Basically, anything that pays a dividend will likely form part of the Canadian dividend fund. There is a third-party manager that manages the fund.

You own units of the fund. They can issue more units or redeem units as needed. You can sell daily, on a daily liquidity for most mutual funds. At the end of the day, the aggregate value of all the shares of the portfolio are valued and divided by the number of units, and that is your unit price every single day.

They go to six or eight decimals, so you know you’re getting the exact value. That’s what you own at the end of the day, and every day you can put a buy or a sell, and the buys as well as the sells are triggered at the end of every single day. Everyone gets the same price that day for a buy and for a sell.

Now, this is contrary to stocks which trade daily on the TSX, or on the Dow or on the Nasdaq. It’s also contrary to ETFs, exchange traded funds, which trade daily on an exchange; those have bid and asks, so you have a bid and you have an ask and if there’s a match on the price, that’s a trade.

The shares go from one to another. That happens millions of times every day for stocks and ETFs. For funds, it happens once at the end of each day, and it’s buying and selling. They get squared off and they’re either more or less units of their trust.

Pros and Benefits of Mutual Funds

The pros are that they’re easily accessible. You can get different niche plays.

For example, you can get the mutual fund for Asia or Europe. You could get small caps, or even get micro caps.

There’s a whole variety of different niche sectors that you can get exposure to.

Another pro is that you can also get diversification. If you have a small amount of assets and you’re looking to start out investing, well you can’t really just go out and buy one share of Berkshire Hathaway, right? Or one share of Google. This allows you to diversify across different sectors.

You get professional management, the exposure and also the liquidity. It’s a lot simpler. Hopefully if you do own these funds, the managers are performing.

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Cons of Mutual Funds

Some would say the greatest con is the fees.

The fees are generally higher than what you would pay with an Investment Advisor. Sometimes there’s not full transparency on all the funds and the fees. Some Investment Advisors might be charging what’s called a deferred sales charge and some might be charging what’s called a low load.

There are fees that are billed in addition, either when you’re selling, or in excess transfer fees. If you’re moving in and out of positions, there can also be different classes of funds which can be unclear in regard to which fee you’re paying.

Transparency can also be an issue. Although, in the past, the government has somewhat made it a priority for them to increase the transparency in mutual fund fees. It’s still to be determined whether that’s working with the end user.

There are certain mutual funds that make sense for some people and groups of investors while certain mutual funds will not make sense for other investors.

It really depends on how much you have in terms of assets, how much you have in terms of net worth, how much you have in terms of volatility, what your liquidity is and who’s managing your assets. There’s a number of different questions that come into play as to whether or not you should own mutual funds.

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You should also know that the tax implications of the fund are split evenly across with everyone. Whether or not you own the fund for the whole year or not, you get the tax implications of that fund, and you don’t get to control that.

If there are buys and sells that are happening inside of the fund, inside of the pool assets and they’re crystallizing capital gains or maybe they’re moving out of stocks and going into income producing investments, you don’t get to control the tax implications of that.

That means that you are now getting the tax consequences along with everyone else in the country. You’re in the same boat as all of them, whether it’s in your favor or not. Unfortunately, that’s not a pro either.

Remember, if you want to discuss mutual funds further, please go to speaktorob.com, and we can schedule a no obligation call to go over any question you may have.

📞 Call us directly at 204-259-2859 to schedule your FREE consultation