How mutual funds work

A mutual fundMutual fund An investment that pools money from many people and invests it in a mix of investments such as stocks and bonds. A professional manager chooses investments that match the fund’s goals for risk and return. You can redeem your fund units at any time.+ read full definition is a collection of investments, such as stocks, bonds and other funds owned by a group of investors and managed by a professional money manager. The investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition objective of the mutual fund determines what types of securities it buys. A mutual fund can focus on specific types of investments. For example, a fund may investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition mainly in government bonds, stocks from large companies, or stocks from certain countries. Or, it may invest in a variety of investments.

When you buy a mutual fund, you’re pooling your money along with other investors. You put money into a mutual fund by buying units or shares of the fund. As more people invest, the fund issues new units or shares.

The investments in a mutual fund are managed by a portfolio manager. They manage the fund on a day-to-day basis, deciding when to buy and sell investments according to the investment objectives of the fund.

4 things to know

1. Risk – The level of risk and return depends on what the fund invests in. Mutual funds are not guaranteed or insured by the Canada Deposit Insurance Corporation (CDIC) or any other government agency – even if you buy through a bank and the fund carries the bank’s name. You can lose money investing in mutual funds.
2. Past performance – How a fund has performed in the past can’t tell you how it will perform in the future. But past performance can help you determine how volatile or risky the fund’s returns may be.
3. Price to buy and sell – You buy mutual funds at the fund’s net asset value (NAV) plus any sales charges. Mutual funds are redeemable – you can sell your mutual funds at the current NAV less any fees and charges for redemption.
4. Fees – All mutual funds have fees and expenses that reduce your investment return.

Net asset value (NAV)

When you purchase or redeem securities of a mutual fund, you pay or receive what is known as the net asset value (NAV) of the security at the time of purchase, switch or redemption. Most mutual funds report their NAV daily in the business section of many newspapers, or on the fund manager’s website. NAV represents the mutual fund’s assets less its liabilities. NAV will fluctuate with changes in the market value of the mutual fund’s particular investments.

2 ways to make money on a mutual fund

1. Capital gains – If you sell your mutual fund for more than you paid for it, you will have a capital gain. If you sell your mutual fund for less than you paid for it, you will have a capital loss.
2. Distributions – Depending on the type of fund you buy, you may also receive distributions of dividends, interest, capital gains or other income the fund earns on its investments. You can choose to receive distributions in cash or have them reinvested in the fund for you. Unless you ask for the distributions to be paid in cash, the mutual fund will usually reinvest the distributions for you.

Fees and expenses reduce the return you get on your investment. Some of these fees are paid by you, and others are paid by the fund. Understand the costs before you buy a mutual fund.

How mutual funds are taxed

If you hold your mutual funds in a non-registered account, any money you make on them is subject to tax. Distributions are taxable in the year you receive them, whether you get them in cash or they are reinvested for you. Interest, dividends and capital gains are all treated differently for tax purposes, and that will affect your return from an investment.

If you hold your mutual funds in a registered plan, like an RRSP, a RRIF or an RESP, you won’t pay taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition on the money you make as long as that money stays in the plan. When money is withdrawn from the plan, it will be taxed as income.

With a TFSA, you don’t pay any tax on the money you make while it’s in the plan – or when you take it out.

Learn more about how tax affects your investments.

Where to buy mutual funds

• Banks and trustTrust An account set up to hold assets for a beneficiary. A trustee manages the assets until the beneficiary reaches legal age.+ read full definition companies
• Life insuranceLife Insurance Insurance that pays cash to your family or other beneficiary after your death. This can give them income and help pay your funeral and other final costs.+ read full definition companies
• Credit unions and caisses populaires
• Mutual fund dealers
• Investment firms
• Mutual fund companies that sell directly to the public.

Most mutual funds are sold through financial advisors who are required to be registered with their provincial regulator (for example, the Ontario Securities Commission). They must also work for a company that is registered to sell funds. You can buy mutual funds without an advisor if you use a discount brokerageDiscount brokerage A brokerage firm that charges lower fees to buy and sell investments, as opposed to a full-service brokerage. Does not provide investment advice.+ read full definition.

Take action

Financial advisors who sell mutual funds are required to be registered with their provincial securities regulatorSecurities regulator A government agency that enforces the securities act in jurisdiction it has authority over. This act is made up of laws that establish rules for issuing and trading securities. The Ontario Securities Commission is the securities regulator for Ontario.+ read full definition. Check registrationRegistration A requirement for any person or company trading investments or providing advice in Canada. Securities industry professionals are required to register with the securities regulator in each province or territory where they do business.+ read full definition and background through the Ontario Securities Commission or Canadian Securities Administrators.

Caution

Mutual funds are not guaranteed. You may not get back the amount of money you invest.