A mutual fund is a type of investment vehicle where money collected from various investors is pooled together for the purpose of investing in different assets including bonds, stocks, and/or money market investments like cash, gold, etc. These investments are all selected by a professional investment manager.
Generally, by investing in a number of different assets, a mutual fund can lower your risk because your money is not dependent on the performance of a single investment.
The Net Asset Value (also referred to as the Net Asset Value Per Share or NAVPS) of a mutual fund is the price at which the shares or units of a fund are traded. The NAV is obtained by dividing the total value of all securities (minus any liabilities) in the fund by the total number of shares or units that are outstanding.
For example, if the assets in a fund are valued at $10 million, the liabilities are worth $1 million and there are 1 million units issued, then:
There are costs including fees and commissions associated with investing in a mutual fund. The fee for investing in a mutual fund is known as the management expense ratio (MER). The MER is expressed as a percentage of your total asset value. Your rate of return is typically reflected net of the MER. This means that you don't have to do an additional calculation when you see your fund's return to calculate how much you have paid.
The MER also consists of the different costs associated with operating the fund. This includes portfolio management fees, taxes and operating costs.
In some cases, the trailing commission (or trailer) is also included within the MER. Trailers are paid to the dealer or advisor servicing your account. For fee-based accounts, the trailer is not part of the MER. In such cases, the fee paid to the advisor is separate from the cost of investing in mutual funds.
Risk and return are related because potential returns increase as the risk in an investment increases. Lower-risk investments tend to have lower returns, but the potential for losses also decreases.
Some assets, like fixed income investments, tend to be less volatile than other assets, like equities. An investor's risk tolerance and investment objectives determine the mix of assets in their investment portfolio.
There are a number of risks associated with investing in a mutual fund. These can include, but are not limited to:
Market risk - The value of a fund is dependent on risks that affect the entire market.
Liquidity risk - Liquidity risk is the possibility that a fund will not be able to convert its investments to cash when it needs to or will not be able to do so at a reasonable price.
Equity risk - When the economy is strong, the outlook for many companies will be good, and share prices will generally rise, as will the value of funds that on these shares. On the other hand, share prices usually decline in times of general economic or industry downturn. In addition, the price of equity securities of certain companies or companies in a particular industry may fluctuate differently than the overall stock market because of changes in the outlook for those companies or the particular industry.
Credit risk - Credit risk includes the risk that the issuer of a fixed income security, like a bond, will be unable to repay their outstanding obligations.
Interest rate risk - Interest rate risk is the possibility that the interest rates are changed by the central bank. Typically, the value of fixed income securities rises when interest rates fall, and vice versa.
International market risk - Funds that invest in securities of foreign issues are subject to additional risks. For example, the value of investments in certain countries may be negatively affected due to geo-political events in the country or region.
Foreign currency risk - The value of an investment held by a fund will be affected by changes to the value of the currency in which the investment is denominated, relative to the base currency of the fund.
At TDAM, each fund is assigned a risk rating. This is based on how much the fund's returns have changed from year to year. It doesn't represent how volatile the fund will be in the future and the rating can change over time. A fund with a low risk rating can still lose money.
An Exchange Traded FundExchange Traded Fund is an investment fund that trades like a stock on an exchange and can experience price changes throughout a trading day as it is bought and sold. Some ETFs are designed to track the performance of the underlying index or benchmark.
An index is a statistical measure of a portfolio of stocks or bonds representing a particular market or a portion of it. Some examples of indices are S&P/TSX Composite Index, S&P 500 Index, FTSE TMX Canada Universe Bond Index, MSCI Emerging Markets Index, etc.
Like market volatility, fluctuations in the value of the Canadian dollar can have an impact on the returns of mutual funds holding foreign securities, such as U.S. equities. For funds valued in Canadian dollars that hold U.S. securities (like stocks), Canadian dollars must be converted to U.S. dollars before buying the U.S. securities and converted back to Canadian dollars when selling the U.S. securities.
This creates an inverse relationship between Canadian currency fluctuations and the value of U.S. securities held by the fund.
When the Canadian dollar falls, the relative value of the U.S. securities rises. This adds to the fund's performance. On the other hand, if the Canadian dollar rises, the relative value of U.S. securities declines, which takes away from the fund's performance.