There are a number of reasons that may prompt younger people to want to learn about mutual funds. Investing is a key component to building wealth, and mutual funds are a great place to start—especially for those new to investing.

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What is a mutual fund?  

A mutual fund is an investment vehicle that pools the money of many investors who share a similar objective (ranging from very aggressive to super conservative) to invest in a professionally managed portfolio of stocks, bonds and other publicly traded securities.

By investing in a fund, you do not own individual shares of the securities the fund invests in, but a piece of the total portfolio of securities—which could include anywhere from a few dozen to hundreds of securities.

Each fund states its goals and objectives in a prospectus. The prospectus is like an owner’s manual for the fund and contains information about the fund’s goals and objectives, the investment strategy that the manager(s) employs and the kinds of investments that the fund will buy, in addition to a breakdown of fund fees and expenses.

Types of mutual funds

There are many types of mutual funds. Mutual funds are often categorized by their investment objectives, or what it is they hope to achieve. Some common mutual fund objectives are as follows: 

Growth funds

Growth mutual funds typically invest in common stocks issued by U.S. and/or international companies that the portfolio manager believes have the potential for above-average growth. Because these funds are generally more aggressive, they are often better suited for investors with a longer time horizon and/or a higher risk tolerance.

Equity income fund

Equity income funds typically invest in dividend-paying stocks and income-producing bonds, depending on the parameters outlined in the fund’s prospectus. These funds are generally not as risky as growth funds, because the income generated from dividends and bonds can help serve as a buffer against equity market volatility.

Balanced fund

Balanced funds generally invest in a diversified mix of stocks, bonds and cash equivalents. These funds often seek a blend of growth and capital preservation, and typically provide smoother and less volatile returns than their growth counterparts over the long term.

Bond funds

A bond fund is made up of debt instruments issued by governments or corporations. Typically, bond funds are designed to provide investors with interest income in the form of regularly scheduled dividends. Bond funds can help investors ride out stock market downturns, but will generally provide lower returns than stock-based funds. Bond funds are also more sensitive to changes in interest rates.

Other types of funds

Funds that provide concentrated exposure to a particular sector, such as technology or healthcare, are called sector funds. Other mutual funds invest in stocks based on the size of the company (e.g., large-, mid- or small-cap companies).

Active vs. passive

One of the advantages of an actively managed mutual fund is professional money management. When you invest in an actively managed mutual fund, part of what you pay for is the fund manager’s expertise. The fund manager analyzes hundreds of securities (both current and contemplated holdings) and decides what and when to buy and sell.

Conversely, index funds are passively managed funds that attempt to replicate the composition and results of a standardized, broad-based index, such as the Standard & Poor’s 500 (S&P 500) Index.

Benefits of investing in a mutual fund

Diversification

Investing in mutual funds is a convenient and easy way to achieve diversification that would otherwise be much more difficult (if not impossible) to obtain on your own.

Small minimum investments

Most mutual funds have low minimum investment requirements. Depending on the fund’s rules, you can open an account and make subsequent contributions with a small initial investment.

Liquidity

Mutual funds are easily converted into cash (i.e., you can redeem your shares).

Choosing a mutual fund

Choosing a mutual fund requires careful thinking about a number of factors. The most important considerations include your investment goals, risk tolerance, time horizon and your overall portfolio allocation.

Before investing in a mutual fund, you’ll want to read the fund prospectus and research the mutual fund. To get a prospectus, contact the mutual fund company directly or download one from the company’s website. Many financial magazines and websites are good sources of information to use in an initial screen for suitable mutual funds.

Other considerations

Fees and expenses

There are costs associated with operating a mutual fund that are typically passed on to investors. These include shareholder transaction costs, investment advisory fees, and marketing and distribution expenses. While not necessarily a deal-breaker, it is a good idea to keep an eye on a fund’s fees and expenses, which have the potential to eat away at long-term performance. 

Turnover

Portfolio turnover is the rate at which a fund changes its investments in a year and is often used as an indicator of how actively a fund manager trades. Aggressively managed funds typically have higher portfolio turnover than conservatively managed funds, which are more likely to buy and hold for the long term. High turnover generally adds to the expenses of a fund and can impact your tax liability.

CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation. Listen to the podcast on mutual fund basics below.