Investing for Beginners – Mutual Funds

The easiest way to think about investing in mutual funds is like purchasing a more expensive but actively managed Exchange-Traded Fund (ETF) with the hopes that the individual or team managing the fund will outperform the market and you will get a higher than expected return on your money. A mutual fund, similar to an ETF, is essentially a large pool of stocks and bonds that are grouped together in a single investment portfolio where – rather than purchasing each investment separately – you can purchase a share in the specific mutual fund and have the benefit of owning a small portion of all of the stocks and bonds currently held. By investing in a mutual fund, you receive your return when the stocks and/or bonds within your mutual fund generate dividends/interest payments and when the mutual fund sells an asset for a gain – meaning that it was purchased for less than it was sold - which creates a capital gain distribution from the fund to you, the investor.

Mutual Funds – Super Easy Difficulty 

Who is running these funds and how do they get paid? Mutual funds are managed by licensed professionals – known as Fund Managers – who get paid a fixed percentage based on how the fund performs over the year. Please note that these fund managers still get paid even if the fund losses money. This is one of those things that bothers a lot of investors. If these fund managers get paid a large amount of money to run these funds even if they make or lose money, they should also be affected if the fund loses money too. This is one of the issues of mutual funds as they are run by fund managers who might not have the motivation to keep the fund in the green (meaning that it makes a profit, rather, the lack of fear of losing money provides them the opportunity to make high-risk, high reward trades in the hopes that they can outperform the market and convince others to invest their money with them. It is a known fact that most mutual funds, some articles even say 90% of these actively managed funds, do not outperform the market and therefore will actually cause you to make less money year over year as the costs of the funds eat away at your profit.

Also, mutual funds have the highest MER (Management Expense Ratio) reaching anywhere from 1.4% to 2.9% of all of the money you invested in the mutual fund. Now this might seem like a lot or a little depending on your understanding of how much it costs to run these funds. To provide an example, if you were to invest $100,000 in one of these funds, even if the fund were to not make you money – assuming in this example that it doesn’t make or lose money and stays at $100,000  – at the end of the year your investment would be worth $97,100. The MER of 2.9% would have cost you $2,900 for no improvement in your investment and this would just be considered the cost of being allowed to purchase shares in this specific mutual fund. To help provide further clarity, if you have taken a look at my ETF blog post, you will note that some ETFs have MERs of 0.06% which would only cost you $60 compared to a mutual fund that would cost you $2,900 a year if you were to invest $100,000. 

So who is buying mutual funds when ETFs are so much cheaper? The people who purchase mutual funds are the same individuals who have deep pockets with no interest in the financial world, who prefer to just let someone else manage their money without thinking of any alternatives as they could not be bothered with researching investments themselves. Mutual funds also cater to people who are older as they did not have the option of ETFs when they started investing many years ago and prefer to stick with investment options and/or brokers that they understand and trust even at the cost of a higher MER. Lastly, individuals who are locked-in to their Employer Retirement plans that provide only mutual funds as options to invest their money in are also forced to pay high MER costs as there is no other option available to them. 

At the end of the day, if you truly want a passive form of investing where you do absolutely nothing and just receive your dividend checks every quarter and you do not mind paying a high premium through a high management expense ratio, than mutual funds are the investment for you!

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