Mostly everyone I know has a mutual fund. So, what REALLY is a mutual fund, you ask?
Mutual funds are a collection of stocks that are professionally managed by a high-paying fund manager. They collect everyone’s money (or whoever is interested in buying the mutual fund) and then pools it together to buy the selected stocks, bonds, and money market funds that they think will provide good return.
They then distribute the gains (or boooo, losses) back to you, the investor.
The pros of mutual funds are:
- Diversification. Everyone in personal finance loves this word. It decreases the riskiness (so if one stock does poorly, then you might be offset by another stock that does well, in another sector) of your investment. Because most normal people don’t have the cashola to buy a lot of stocks to diversify, the mutual fund is meant to help you do just that.
- A Professional Does the Stock Picking for You. A fund manager picks the fruit so you don’t have to worry about it. These people are trained (hopefully…nervous laughter) to find the best picks the ensure that the fund has a good return of capital. That being said, many times the S&P index beat a plethora of mutual funds. Which means that even with professional management, your fund could still suck, and your money could be going nowhere.
- Guaranteed Principle. Some big banks have mutual fund options that guarantee your principle investment, say if you hold your cash with the bank for a minimum of five years.
The cons of mutual funds are:
- FEES! The Management Expense Ratio fees aka MER’s are what kills ya. They can cost anywhere from 1.5 to 3.2% a year, depending on the company. I was with Investors Group for a bit in the beginning of my foray into personal finance. The financial adviser I gave my $5000 to neglected to tell me he was making a pretty penny (3.2%) off my investment, he kept saying that they have “no commissions”. But the MER is sort of like a commission for the financial adviser. So on a $5000 investment you’re possibly out $175, EVEN if the mutual fund is losing money. Where does this hard earned money go? Some of it goes to the fund manager, your financial adviser (so heads up if they seem pretty keen on getting you that fund, because they might be getting a big commission from selling you a piece of the pie, instead), and other costs of keeping the fund professionally managed. The important piece of this to take away is that if you want that compound interest really working for you, you have to lower your investment costs.
- Sometimes hard to find how well your fund’s doing. Sometimes it can be hard to find how well (or poorly) your fund is doing. Sometimes once your financial adviser gets your money and sells you the fund, they become MIA. This happened to me and I only found out how poorly my fund was doing about a few times a year, when they send you those quarterly statements. I recently found out you can track your funds ONLINE (just ask your financial adviser for the login addresses and ID’s) and since then, my financial advisers seemed to have smartened up a bit and check-in with me a bit more frequently.
- Not Traded on the Exchange. Because they’re not traded on the exchange, you don’t have to pay a trading commission each time you buy more of the fund. Trade commissions can cost anywhere from $4.95 to $29 a pop (each time you trade).
So how does one avoid paying for costly MER’s? The beautiful balance is to find either an Exchange Traded Fund (remember how I said that the index has historically provided better returns that actively managed funds?) or an E-fund.
One of the ones that I like is the TD E-Series Fund. It has a low MER, I think 0.5% is one of the highest they have. Because you skip the middle man (the financial adviser, banks etc.) it’s cheaper for you. Hurrah! We can have our cake and eat it too. The trick is that they’re hard to apply for, but once you get it, it’s easy peasy. In my next post, I’ll talk about how to apply for a TD E-series fund with the least amount of hassle.
What do you think of mutual funds? Do you like them or do you prefer to use ETF’s?