What is a mutual fund?
Here’s what you need to know about mutual funds and their basic features.
CIBC Investor’s Edge
Jan. 20, 2021
3-minute read
A mutual fund is an investment that pools money from many investors in order to purchase a basket of securities, such as stocks and bonds. You put money into a mutual fund by buying units or shares of that fund. Mutual funds can be a good way to have a range of investments without managing them on your own.
Here are the basic features of a mutual fund.
The net asset value (NAV) is the price to buy and sell shares of a mutual fund. You buy mutual funds at the fund’s NAV plus any sales charges. The funds’ NAV will fluctuate with changes in the market value of the mutual fund’s particular investments. Unlike stocks and ETFs, which trade at any time during stock market hours, mutual funds transact only once per day after the fund’s NAV is determined when stock markets close.
Investment objective determines what types of securities the mutual fund is allowed to buy. Each fund focuses on specific investments, like government bonds, stocks from large companies, stocks from certain countries, or a mix of stocks and bonds. The level of risk and return depends on what the fund invests in.
Holdings (such as stocks, bonds and cash) in a mutual fund are managed by a professional portfolio manager. They manage the fund on a day-to-day basis, deciding when to buy and sell investments according to the investment objective of the fund.
There are two ways mutual funds are typically managed. Portfolio managers who actively manage the mutual funds research and hand-pick investment holdings according to the fund’s investment objective. This approach focuses on trying to generate higher returns than the market. In passively managed mutual funds, portfolio managers will match the holdings of the mutual fund with an index (for example, the S&P 500). This approach aims to mimic the investment holdings and the performance of a particular index, and requires minimal research and analysis.
All mutual funds have fees and expenses (called a management expense ratio or MER) that reduces your investment return.
All mutual funds are required to have a benchmark. A benchmark is used to measure the performance of a mutual fund or any other investment. This comparison against the benchmark gives an insight into how well the fund manager has invested your money and managed the fund over time. Only then can an investor know if the fund outperformed the market, matched the market or generated a lower return. For example, a stock market index, such as the TSX 60 or S&P 500, is a benchmark you can use to compare how well your own stocks or equity mutual funds are doing.
Most mutual funds will often pay a distribution — similar to a dividend. The distribution frequency will depend on what the mutual fund is designed to accomplish. For example, you can receive monthly, quarterly, semi-annual or annual distributions. Unlike a stock, which generally only pays dividends (in the form of cash or more stocks), a mutual fund distribution can generally be composed of interest, dividends, capital gains and return of capital. Each one is taxed differently.
