Investing in Mutual Funds – A Complete Guide

Mutual funds are a portfolio of stocks, bonds, or other securities. They pool money from individual investors, then use that money to build a diversified portfolio of investments.

Mutual funds explained

Mutual funds are built and managed by professional money managers who decide when to buy and sell stocks, bonds, or other assets held within the fund. They typically include a range of different investments, making it easy to invest in a range of different securities.

How do mutual funds work?

When you invest in a mutual fund, you’re buying a share of all of the assets held within the fund. 

Pricing: The price of each share depends on the value of assets held within the fund. A mutual fund’s price is based on the fund’s net asset value (NAV) per share. A funds NAV is calculated by dividing the total value of all the assets held within the fund by the total number of shares outstanding. The total number of shares outstanding includes all shares held by shareholders, investors, and company officers and insiders.

Returns/Earnings: Mutual funds typically pay quarterly or annual returns to investors. Mutual funds generate returns for investors by:

1. Paying dividends on stocks and interest on bonds held with the fund.
2. Paying capital gains on any securities that are sold at a profit
3. Increasing in value and allowing investors to sell fund shares at a profit

Tax: The amount of tax you pay on any profits generated by mutual funds will affect your overall returns. Profits earned from mutual funds held within non-registered accounts are subject to tax. Interest payments, dividends and capital gains are all taxed at different rates. Profits earned from mutual funds held within registered accounts like a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), or Registered Education Savings Plan (RESP)  won’t be taxed until you withdraw them. You won’t pay any taxes on profits earned from mutual funds held within a TFSA. 

Mutual funds provide a range of benefits to investors. Here are a few of the benefits provided.

Diversification

As mutual funds tend to invest in numerous securities, it can reduce the risk associated with investing in a single security.

Professional Management

Mutual funds are built and managed by professional money managers, letting you benefit from their investment knowledge and expertise.

Liquidity

Mutual fund shares are easily sold, or liquidated, letting you access your money quickly and easily.

Accessibility

Mutual Funds provide access to variety of securities and markets. Moreover, fees associated with investing in mutual funds can be less than fees associated with frequently buying and selling individual stocks and bonds.

Different types of mutual funds will be subject to different types of risks. For example, equity funds are primarily subject to market risk, but they can still be indirectly affected by credit risk to some extent. On the other hand, bond funds are subject to both credit risk and market risk. The specific balance of risk in a fund depends on its portfolio composition, including the types of assets it holds and their credit ratings. It's important for investors to consider these risks when choosing funds based on their financial goals and risk tolerance.

Market Risk

This refers to the risk associated with fluctuations in the stock market. There’s always a risk you will lose some or all of your initial investment. Mutual funds are subject to the same market risks as any other investment, so a downturn in the market could reduce the value of any mutual fund shares you own.

Credit Risk

If the companies in which the fund has invested experience credit issues or default on their debts, it can impact the fund's performance. Bond funds are exposed to credit risk, which is the risk that the issuers of the bonds held in the fund may default on their interest payments or fail to repay the principal amount at maturity. This risk is more pronounced in lower-rated or high-yield bond funds, as they invest in bonds with a higher likelihood of default.  While credit risk largely impacts bond funds, equity mutual funds can also be indirectly affected by it to some extent, especially if they invest in companies with high debt levels or credit concerns. 

Liquidity Risk

If the assets held within a mutual fund are hard to liquidate, it may take longer for the fund to meet redemption requests.

Concentration Risk

Investing in multiple mutual funds that invest in the same markets or sectors can expose you to concentration risk. If those markets or sectors decline, the value of your investments will all decrease at the same time.

Active vs. Passive Mutual Funds

Active mutual funds are constantly being monitored and adjusted by professional money managers in an effort to outperform the market. Passive mutual funds are usually built to mimic, but not necessarily beat, the market’s performance. Because they are actively managed, active mutual funds tend to have higher expense ratios and fees than passively managed funds.

Equity Mutual Funds

Equity mutual funds primarily hold equities, or stocks, and are often referred to as Growth Funds. Equity funds can be classified through various categories such as Large Cap, Mid Cap, Small or Micro-Cap funds based on the market value of all stocks held in the mutual fund. Equity funds can also be classified as Diversified or Sectoral. A Diversified Equity Fund will invest in a range of stocks from different sectors. Sectoral funds only invest in companies from a single industry or sector.

Bond Mutual Funds

Bond funds are primarily made up of bonds and other debt instruments and are designed to provide investors with a regular source of income. Interest payments are typically paid out to investors each month and will vary depending on how much interest is earned on bonds held within the fund.

Money Market Mutual Funds

Money market funds primarily invest in highly liquid assets like cash, cash equivalent securities, and high-credit rating, debt-based securities with a short-term maturity. These funds are generally low risk and offer investors high liquidity.

Index Funds

Index funds are made up of a collection of stocks held within a given market index. Instead of trying to beat the market, index funds try to match the market, and mirror the market’s performance over the long term.   

Balanced Funds

Balanced funds invest in two or more different asset classes as it aims to provide a mix of capital appreciation and income, and benefits of both equity and bond funds with broader diversification. This helps ensure greater variation within the fund and limit concentration risk for investors.

Step 1: Understand Your Investment Goals

Start by setting some investment goals. Are you working toward short-term goals like saving for a down-payment or long-term goals like retirement? Think about how much money you’re looking to earn, how much you can afford to invest, and how much time you have to reach your goals.  

Step 2: Evaluate Your Risk Tolerance

Consider how much risk you’re willing to accept. If you’re worried about losing money during market fluctuations, you’ll probably prefer to invest in lower risk investments that pay lower returns. If you’re willing to risk short-term losses, you may be willing to invest in higher risk funds that offer higher potential returns.

Step 3: Research Different Types of Funds

Mutual funds come in all shapes and sizes. Some funds include investments from specific markets or industries, while others are more diversified. Which mutual funds may be right for you will largely depend on your risk tolerance and investment goals. Regardless, the more research you do the more confident you’ll feel about your investments.

Step 4: Choose Where to Buy Mutual Funds

Mutual funds can be purchased through a broker, directly from a fund provider, or through an online brokerage. TD Direct Investing makes buying mutual funds easy and offers a wide range of low-cost mutual funds for self-directed investors to choose from.

Step 5: Decide on an Investment Amount

Decide how much you’re willing and able to invest. Some mutual funds require a minimum initial investment, while others don’t. When it comes to investing, there’s no right or wrong amount to choose. It all depends on what you can personally afford. Moreover, you can also opt to make recurring contributions through Systematic Investment Program (SIP).

Step 6: Choose a Fund and Open an Account

TD Direct Investing provides self-directed investors with a wide range of funds to choose from any financial institution. You can choose professionally managed funds, low-cost D-series funds, or passive investment index funds. Once you find a fund or series of funds right for you, simply open a TD Direct Investing Account to get started. You can choose from Registered Retirement Savings Plan (RRSP), Tax Free Savings Account (TFSA), Registered Education Savings Plan (RESP), Cash account among others depending on your financial goals and profile.

Step 7: Manage and Monitor Your Portfolio Regularly

Once you’ve purchased the assets, it’s important to regularly monitor and manage your investments. Financial experts recommend reviewing your portfolio once a year to make sure it’s performing as hoped and to make any adjustments as needed.

How Can Beginners Invest in Mutual Funds?

TD Direct Investing makes it easy for beginners to invest in mutual funds. Just open a TD Direct Investing account online, transfer funds into your account, and start building your portfolio.

Are Mutual Funds a Good Investment?

Mutual funds can be a great option for investors looking to invest in a diversified portfolio of assets. Mutual funds are affordable and let you benefit from the expertise of experienced investment professionals.

How Do I Start Investing in Mutual Funds?

It's easy to get started as self-directed investor. Select the TD Direct Investing account you want to open online or book an appointment. Next, research mutual funds to find one that’s right for you. TD Direct Investing offers research tools such as screeners that allows you to filter mutual funds based on the criteria that's important to you.

How Can You Make Money from Mutual Funds?

Mutual funds generate profits by:

1. Increasing in price while you own the fund, resulting in an increase in the fund’s NAV
2. Paying dividends on stocks and/or interest on bonds
3. Producing capital gains if the fund sells investments at a profit

Are Mutual Funds Good for Beginners?

Mutual funds are great for individuals new to investing. They make it easy to invest in a diversified portfolio and let you benefit from the knowledge and expertise of professional money managers.

Investing in mutual funds can be an easy and cost-effective way to adopt a diversified investment strategy. There are lots of different kinds of mutual funds to choose from, and you’ll benefit from the knowledge and expertise of professional money managers. Investing in mutual funds can be particularly beneficial for new investors with limited time and money to invest in building a diversified portfolio of their own.

And the best part is, all you need to do to get started is to open up a brokerage account. If you don’t already have one, you can open one quickly and easily today with TD Direct Investing.