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Understanding Mutual Funds: Key Features and Benefits

Explore the characteristics of mutual funds, including professional management, diversification, and share types. Learn about net asset value, index funds, ETFs, load funds, and management fees in the world of investing.

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Understanding Mutual Funds: Key Features and Benefits

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  1. LO#1 Learning Objective # 1Describe the characteristics of mutual funds.

  2. LO#1 Why Investors Purchase Mutual Funds • Professional management • Who is the fund’s manager? • Managers can change so investors must be careful • Diversification • Investors funds are pooled and used to purchase a variety of investments. • Funds own stock in hundreds of different companies • Buys from different asset classes (stocks, bonds & other securities • Investment Company • A firm that, for a management fee, invests the pooled finds of small investors in securities appropriate to its stated investment objectives

  3. LO#1 Characteristics of Mutual Funds • Closed-end Mutual Funds • A fund of finite size • Shares are issued by an investment company only when the fund is originally set up • After all original shares are sold you can only purchase shares from another investor • Open-end Mutual Funds • Shares are issued and redeemed by the investment company at the request of investors. • Investors can buy and sell shares at the net asset value.

  4. LO#1 Characteristics of Mutual Funds Net Asset Value • The current market value of the securities contained in the mutual funds portfolio minus the mutual funds liabilities divided by the number of shares outstanding • Calculated at the close of trading each day (Value of the fund’s portfolio – Liabilities) Number of shares outstanding

  5. LO#1 Characteristics of Mutual Funds • Index Fund • An affordable way for investors to invest in a diversified basket of securities; constructed to track the components of a market index such as the S&P 500 or the S&P/TSX Composite • Exchange Traded Funds (ETF’s) • An affordable way for investors to invest in a diversified basket of securities; provides the diversification of an index fund with the flexibility of a stock • Short Sell • The practice of selling a borrowed stock in the hope of covering the sale by buying it at a lower price later

  6. LO#1 Characteristics of Mutual Funds • Load Fund • A mutual fund in which investors pay a commission (as high as 8.5%) every time they purchase or sell shares • Contingent Deferred Sales Load – pay upon withdrawal of funds • No-Load fund • No sales charge • Front-end load • A sales fee charged with each purchase; reduces the funds actually invested. Most fund companies have lowered the maximum front-end load on their funds to around 6 % • Back-end load • Also referred to as a contingent deferred sales load. One to six percent of withdrawals on sliding scale decreasing with time held, then zero if selling after a set number of years.

  7. LO#1 Management Fees & Other Charges • Expense Ratio • Expressed as a fixed percentage of the fund’s total value, called the Management Expense Ratio (MER). Ranges from 0.25 percent (rare) to 4 percent, to cover investment company’s costs. Fee is up to 0.5 percent higher for back-end load funds. • Special Fees • Annual RRSP, RRIF, RESP trustee fee • Account set up fee • Short term trading fee • Processing fee • Service fees

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