Mutual funds are becoming an RRSP staple
Every year millions of Canadians invest in RRSP mutual funds. Many people who go through the annual RRSP contribution ritual are investing to take advantage of tax breaks. However, they may be unaware of how mutual funds work and the options available to them. What exactly is a mutual fund and why are they so popular?
"There's no doubt that mutual funds today are a preferred investment vehicle," says Andrew Beer, Manager, Investment Planning. Beer explains that because interest rates are at low levels, fixed-term investments such as GICs are a less popular choice for RRSPs.
"A well-designed investment plan would likely include mutual funds, because they offer good returns over the long term," he adds.
How mutual funds work
Mutual funds receive money from many investors. A professional portfolio manager uses this pool of cash to build a portfolio containing shares of companies and/or a variety of interest-bearing investments. Mutual funds have more variability than guaranteed-income investments, Beer observes, but adds that diversification within the funds helps reduce overall risk. There are several types of funds:
Money market fund
A portfolio of short-term investments offering safety and liquidity, such as T-bills, issued and guaranteed by federal and provincial governments. They're a higher-yielding alternative to savings accounts.
Equity fund
A mutual fund that invests primarily in shares of companies that are available on stock markets, some invest around the world. The objective of an equity fund is usually long-term growth through capital appreciation: as a company grows and prospers, the value of its shares grow in value.
Fixed income fund
A mutual fund that invests in government, corporate bonds and mortgages. In addition to generating interest income, a fixed income fund may generate capital gains or losses as a result of interest rate changes and the financial wellbeing of the issuer.
Balanced fund
A mutual fund that holds both stocks and bonds, and might include other asset groups like real estate. Portfolio managers may vary the mix as economic conditions change. A balanced fund may produce a mix of earnings from capital gains and dividend and interest income. Balanced funds carry lower risk than equity funds although their returns are generally lower.
Dividend Funds
The funds seek to provide both dividend income and long-term capital appreciation by investing primarily in high quality dividend-paying companies. In addition, investing in these funds can provide an opportunity to diversify the sources of yield in a portfolio.
Specialty funds
These mutual funds typically invest in only one sector. For example, real estate funds own office buildings and shopping centres. Ethical funds, such as Investors Summa Fund, avoid companies involved in such things as tobacco, alcohol, gambling, weapons or pornography.
With the many choices available to investors today, Beer suggests seeking advice from a qualified financial planner. He also advises investors look at mutual funds as long-term investments. "Don't let yourself be spooked by fluctuations in the market. Varied investments within a fund allow it to withstand short-term blips and provide solid returns over the long term."
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This article, written and published by Investors Group, is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
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