Different Types Of Mutual Funds
June 7th, 2010 Posted in Investing, Mutual Funds
Mutual Funds 101: Part 2
The following is an Excerpt from my first book Invest Now. Invest Now is jam-packed with timely information and timeless advice for the beginning Canadian investor. Invest Now covers a broad range of topics including Internet Scams. To purchase a copy, visit Chapters Indigo or click here to buy online - Invest Now: A Canadian’s Guide to Investing
Types of Mutual Funds
Open-End and Closed-End Funds
Before I describe the different types of funds, you need to know about open-end and closed-end funds. Most of the funds investors deal with are open-end funds. Open-end funds have unlimited units to sell and buy, as long as the fund manager is not closing or capping the fund. Closed-end funds have fixed numbers of units and trade on a stock exchange, just like stocks. An example would be the DDJ High Yield Fund, which trades on the Toronto Stock Exchange under HYB.UN.
These days, mutual funds are a hot commodity. Roughly 11,000 funds are available in North America. In other words, funds outnumber stocks.
In the basic level, there are three types of funds.
1. Equity funds
2. Income funds
3. Money-market funds
Your portfolio must include both equity funds and income funds. Shortly, I will show you my model portfolio to help you build your own. I will not include any money-market funds in my model portfolios, as money-market funds are just like interest-paying savings accounts. First-time investors should not be investing just to collect interest.
If you would like to follow a more conservative approach, you can add 5%-10% money-market funds into your portfolio.
Now, let me explain these three types. We will start with equity funds.
Equity Funds
As the name says, equity funds are made of equities, or stocks. Just as there are different types of equities, there are different types of equity funds. Fund managers can choose value or growth styles to manage equity funds (these styles are varied along a spectrum, but I will stick to the basics). Growth-fund managers pick the fastest-growing and often well-known companies to earn an above-average return. Growth managers will not care about stock price; they are willing to pay higher prices. Growth funds tend to be volatile. Value managers are looking for value or stocks that are trading at lower than their real value. Value funds are conservative funds that typically carry less risk than growth funds. Value managers hope to make profit from capital appreciation (meaning the profit will be made by selling stocks when they go higher).
Income Funds
Income funds are also known as fixed-income funds or bond funds. These funds are designed to give you a steady stream of income to diversify your portfolio. Income funds are supposed to give you more income than savings accounts or GICs. Like any investment, income funds are not risk-free. Senior and conservative investors tend to like income funds more than other investors.
Money-Market Funds
Money-market funds are like savings accounts that pay high interest. The unit value does not fluctuate, and the fund pays a monthly dividend or interest. Money-market funds should only be used to park money for a few days.
Some Other Types
Let’s briefly examine the following types of funds, just to give you an idea.
Ethical funds: These funds will not invest in companies that deal with alcohol, tobacco, weapons, environmental pollution, the injuring of animals and so on. In Canada, not many fund companies offer ethical funds.
Sector funds: These are industry-specific funds-such as telecommunications, health science, biotechnology and so on. These funds can give you higher rate of return if your sector does well, but also can take a nose-dive if your sector tanks.
Regional funds: These funds are concentrated in specific regions, like the Pacific region, an emerging-market region, the Eastern European region, the Asian region and so on. Like sector funds, these funds can be risky and have higher MERs.
Segregated funds: This chapter would be incomplete without a discussion of these funds. A segregated fund is a mutual fund with an insurance wrapper; you can call it a hybrid fund. This type of fund offers the growth potential of a mutual fund plus some insurance protection features. Usually insurance protection guarantees your capital up to 100% at death and at maturity. To benefit, you have to either die or stick to your funds for ten or more years. This confuses investors. If you redeem your funds before ten years, there are no guarantees, and if markets perform badly, you will be losing your money in addition to paying a high MER. Segregated funds offer many other added features, but I will not discuss those, as there is no point in paying a high MER for features that won’t exist for a decade. In the long run, holding segregated funds can cost you hefty fees, dragging down the rate of return. If you are that sensitive about money and need insurance features to protect your money, maybe you should avoid investing altogether. Let me give you an example of how MERs can vary between the two same funds.
CI Global Fund: 2.36% MER
CI Global GIF Class A Fund: 4.68% MER
(MER Source: CI’s Web site at www.ci.com)
Specialty funds: Many fancy funds exist: hedge funds, labour-sponsored funds, institutional managed funds, fee-based wrap funds, and so many more. Remember one thing: these fancy funds charge you fancy fees . and at the end, they empty your pockets. Stick to simple funds with low MERs or to plain index funds. I really like index funds and have dedicated an entire chapter to them.
Miscellaneous
- “Portfolio” refers to the main account under which you hold all your investment products. If you hold stocks, bonds, and mutual funds in one place, you can say you hold these in your portfolio.
- An annual report is different from a prospectus. You will find your fund’s holdings (all of them, including stocks, bonds, T-bills and so on) and financial statements in an annual report. The annual report gives you some other important information as well. It’s a good idea to check both the annual report and the prospectus.
- Young and aggressive investors tend to like equity funds more than other investors.
- Mutual funds can be categorized by the market capitalization of the stocks. Small-cap funds hold small-cap stocks. Small-cap companies have a market capitalization of less than 500 million dollars. Mid-cap funds hold mid-cap stocks. Mid-cap companies have a market-capitalization of 500 million to 5 billion dollars. Large-cap funds hold large-cap stock. Large-cap companies have a market capitalization of over 5 billion dollars.
- Balanced funds are just a blend of equity and income funds (typically 60% equity and 40% income). These funds are supposed to balance capital appreciation, income and safety.
- A global fund invests throughout the world, including in your own country. An international fund invests internationally, excluding your own country. In Canada, global funds hold a good portion of U.S. stocks, but international funds do not.
- The term “segregated” refers to the insurance companies’ need to keep segregated-funds assets separated from their other products’ assets.
Links:
A Dawn Journal Mutual Funds Section
How to Build an Investment Portfolio
What Is An ETF (Exchange Traded Funds)?
What Are Mutual Funds? Advantages and Disadvantages of Mutual Funds
