Mutual funds continue to be one of the most popular investment options for Canadians. According to the Investment Funds Institute of Canada (IFIC), sales of mutual funds in February 2015 (just prior to the March 2 RRSP deadline) were $10.8 billion. This was double the $5.36 billion sold in January 2015 and significantly higher than the $9.27 billion sold last February.
This may not be surprising, given today’s low interest rates for fixed-income alternatives such as guaranteed investment certificates (GICs). Also, mutual funds are simple to buy and usually have low minimum purchase requirements.
Mutual funds also provide an easy way to help diversify your portfolio. This is because they invest in a group of stocks, bonds or other securities selected by a professional fund manager. When you buy units of a mutual fund, you’re pooling your money with other investors. So, if you’re a small investor, this enables you to own a much wider mix of investments than you would likely be able to afford on your own.
But it’s important to understand the differences among the three main categories of mutual funds:
1. Balanced funds
The number-one type of mutual fund chosen by investors this past February — with total net sales of $8.56 billion — was a balanced fund. Just as their name implies, these funds provide you with a balanced mix of equity and fixed-income investments. Their goal is to provide the opportunity to benefit from a potential upswing in the equity market, while reducing downside risk by having a mix of, say, 60% equity and 40% fixed income investments.
2. Equity funds
In second place — with total February net sales of $1.99 billion — were equity funds. These funds invest in a variety of different kinds of stocks. While they are considered riskier than balanced funds, they offer the potential for higher returns over the long term. They also enable you to further diversify your portfolio by selecting a mix of different types of equity funds, classified by geographical location, industry sector or investment style.
3. Bond funds
The third most popular mutual funds selected by investors in February -- with total net sales of $2.60 million — were bond funds. These funds invest in fixed-income securities such as government and corporate debt. Their goal is to provide steady income while offering a less-risky alternative than equity funds. However, they are subject to a potential drop in value if interest rates rise. Their level of risk also varies depending on the specific type of bonds in which they invest. For example, a fund investing in government securities would be far less risky than one investing in lower-grade “junk” bonds.
Each type of mutual fund has a different level of risk and return, so each will behave differently over time. If you’re a young investor saving for retirement, with plenty of time before you’re likely to withdraw the funds, you may wish to consider allocating more of your portfolio towards equities — perhaps a split of 60% equity funds and 40% bond/balanced funds.
As you get closer to retirement, you may want the comfort of a more income-oriented portfolio — with perhaps only 40% equity funds and 60% bond/balanced funds — even if it means giving up some of the potential for higher growth in exchange for lower but generally steadier returns.
And, because various types of funds may behave differently over time, a periodic review and rebalancing of your portfolio will help ensure it maintains the right asset mix, based on your current circumstances. Keep in mind as well that past performance is never a guarantee of future results.
A financial advisor can help you set, maintain and modify an investment strategy based on your risk tolerance, time horizon and financial goals.