Purchasing mutual funds tips


I purchase both mutual funds and ETF’s without a financial advisor, and I will talk about how I purchase mutual funds.

When it comes to individual investors purchasing mutual funds, he/she will often buy the ones that have a history of high returns.  Unfortunately, this often does not equal high returns.  Therefore, I will provide insight into what I look for when I purchase mutual funds.

NOTE:  The numbers below correlate with the pictures below from both morningstar.com and theglobeandmail.com investing pages.

  1. MER – When it comes to any managed fund, it will charge a yearly fee.  Therefore, I will always look for mutual funds that have a MER of 2%/year or less.  Index tracking funds (ETFs) will usually charge less than 2%/year MER.  Although, I did purchase some mutual funds that have an MER of 2%/year or more.  Therefore, if a mutual fund produces a return of 10% for that year, the return to the mutual fund holder is actually 8% for that year.  10% actual – 2% yearly fee = 8%.  Same goes for a loss.  A mutual fund that goes down 10% will be a 12% loss for that year for that mutual fund holder.
  2. Load Type – The ones that I look for are always No LoadFront load charges a fee to purchase the mutual fund while back load charges a fee to sell the mutual fund.  Therefore, to avoid the surprise additional fees, purchase No Load mutual funds.  Deferred sales charge (DSC) can be considered the same as a back load since you will be charged a fee when you redeem the mutual fund too early.  DSC is one of the preferred method for financial advisors when selling mutual funds since there is no fee charged up-front.  NOTE:  A more in-depth look into load types can be found at http://www.investopedia.com/ask/answers/125.asp
  3. Min. Invest(Initial) – Being the poor investor I am, I am unable to fork out a $25,000 minimum initial investment.  Therefore, this should be the first thing one looks at in any mutual fund.  If the Min. Investment amount is beyond your budget, there is no need to look further.
    NOTE:  I would like to mention that mutual funds that require a large min. investment usually have a lower MER than mutual funds with a smaller min. investment.  Quite often there will be 5 or 6 identical mutual funds with varying MER and requirements.
  4. Load – Same as number 2 above.
  5. Turnover – A mutual fund that has a high turnover will incur capital gains taxes.  Therefore, a low turnover mutual fund is preferred for taxable accounts.  For RRSP and TFSA accounts, turnover can be ignored.  The reason can be seen at http://www.taxtips.ca/taxrates/bc.htm which details how much tax is being paid on capital gains.
    NOTE:  A high turnover mutual fund is not always a bad thing.  If the mutual fund is providing returns of 50%/year vs 10%/year on average for other mutual funds, the taxes paid maybe worth the gain for taxable accounts.
  6. Min. Inv. – Same as number 3 above
  7. Asset Allocation – Depending on the investor, one may decide to have stocks and/or bonds inside the mutual fund.  There are  other security types, but this is a good indication of what this mutual fund invests in primarily.  In the case of the BMO Dividend, all stocks.
  8. Fund Geography – I need to know if my mutual fund is Canada only, or somewhere else.  Therefore, looking at this will help an investor figure out where this mutual fund invests in.  In this case, this mutual fund invests mostly in Canadian stocks, but I will need to dig deeper to figure out what the rest are.  Although, it may not be that important.
  9. Investment Style –  Looking at the box below and the table shown at Morningstar’s BMO Dividend profile, BMO Dividend is a Balanced, Large Cap mutual fund.  The definitions are:
    Value – Companies, corporations, and business stocks considered undervalued (below market value or bargain stocks) by the mutual fund manager(s) are bought for this mutual fund.
    Balanced – Company, corporations, and business stocks will be bought for this mutual fund that will be a bit of value and a bit of growth.  It would be nice to find stocks that are both cheap(value) and growing(growth), but in business, there is no guarantees.
    Growth – Companies, corporations, and business that show signs of growing will be part of this mutual fund.  Therefore, overpriced company stocks will be purchased if there is a possibility of further growth and stock price increases.
    Large Cap, Medium Cap, Small Cap – Companies, corporations, and business are classified by size into 3 categories.  Unfortunately, there are some companies, corporations, and business that should be considered small cap that are in medium cap mutual funds and other variations.  Although, everyone probably has their own idea of what is a large sized business, medium sized business, or small sized business.  A definition of medium cap business can be seen on investopedia.com at http://www.investopedia.com/terms/m/midcapstock.asp

    Company Value Balanced Growth
    Large Cap X X X
    Medium Cap X X X
    Small Cap X X X
  10. Equity Sector Weightings – What sectors does the fund invest in.  I prefer stocks that have a hand in many sectors.  A fund that invests 50% in one sector that I am unsure about will make me nervous.  Although, this one that invests heavily in financials is something I do not mind.

One thing to keep in mind is that not all mutual funds are created equal.  For example, I have seen mutual funds that charge a MER of say .5%, but it buys 100% of an IShares ETF that charges an MER of say 0.17%.  To me, this seems pointless.  The mutual fund holder is being charged twice.  Why not just buy the IShares ETF?

Another term that people should know is a fund of funds.  A fund of funds is a fund that invests in other mutual funds.  For a more detailed look, one can read it at http://www.fundshedge.co.uk/fundoffunds.htm

Therefore, if one has $500 to invest, but he/she does not want to invest in just one mutual fund.  A fund of funds is an option since $500 is the minimum initial investment for many mutual funds.

The final piece of the puzzle is the breakdown of the returns.  One needs to know how the income will be taxed.  In the case of BC, Canada for the first $35,859:

  1. Other income = 20.06% (I assume that Interest Income, Return of Capital, and Foreign Income is taxed in this bracket)
  2. Capital gains = 10.03% is taxed on 50% of the capital gains.
  3. Canadian dividends = -12.59% (Canadian corporations pay taxes on the shareholder’s behalf.  Therefore, based on the shareholder’s current income, the taxes paid will be negative if the shareholder’s current income is too low.)
  4. Small business dividends = 4.16%

Therefore, based on the above criteria, one wants to avoid any income that will be considered other income.  http://www.taxtips.ca/taxrates/bc.htm provides the taxes payable in BC.  Unfortunately, Morningstar.com and theGlobeandMail.com do not provide accurate payout details.  Therefore, one will need to look at the corresponding mutual fund to find out what the payout is considered.

http://v1.theglobeandmail.com/partners/free/globeinvestor/income/tax_free_living.html explains why Canadian dividends are negative.

The one shown above is morningstar.ca’s type of distribution while the one below is from BMO’s website. I find that, in many cases, one needs to ask the company offering the mutual fund and/or look at the actual companies website for accurate information on what the payout is classified and how it will be taxed. Just because morningstar.ca says Interest Income does not mean it will be taxed as Interest Income. Some maybe taxed as Canadian dividends.

In the end, choosing mutual funds is easier when one knows what to expect. Furthermore, many banks will allow one to purchase in-house mutual funds using a TFSA account. The advantage of purchasing in-house mutual funds this way is that one will not be charged a financial adviser, brokerage and/or yearly management fee. Although, the MER is still charged and the mutual funds must be purchased using the online banking system without an adviser.

Difference between a financial adviser and a mutual fund manager

A mutual fund manager within a mutual fund is the one who will use his/her stock trading skills to make money from the stock markets while the financial adviser is there to provide his/her expertise in what mutual fund you should add or delete from your portfolio based on the returns expected.

What can one expect when purchasing from a financial adviser?

A financial adviser is trained to choose funds that fit your risk tolerance and are age appropriate.  He/she will ask questions and determine what is best for you.

A commission-based financial adviser is compensated by the mutual fund(s) held in your portfolio.  Therefore, the financial adviser will not charge you an hourly consulting fee.

A fee-based financial adviser who charges hourly for his/her time will recommend funds that fit your needs, but will not get compensated by the mutual fund(s).

As a client, you will have to decide which adviser suits your needs.

How to open an account to buy or sell mutual funds without an advisor.

Before opening a RRSP, savings or TFSA (Tax free savings) account to purchase in-house mutual funds, one should ask the following questions:

  1. Does your bank offer a TFSA and/or savings account that can purchase in-house (own brand) or other mutual funds?  If the answer is yes, then the following can be asked.
  2. I would like to purchase no load and no adviser fee in-house mutual funds.  How can I purchase these if possible?  In most cases, the transactions must be done online to avoid extra fees.
  3. Will I have to pay a management fee to manage my savings or TFSA account that has in-house mutual funds?  Opening a stock trading account has a yearly or quarterly management fee, so does a savings or TFSA account that buys in-house mutual funds incur the same fees?
  4. How much does it cost to buy and sell in-house mutual funds using my savings or TFSA account?  Some banks may charge a brokerage fee while others do not.  Therefore, it is a good to ask.
  5. Is there any restrictions on what kinds of mutual funds I can buy?  For example, can I purchase 100% International mutual funds?  In some cases, banks will have two types of accounts.  Restricted and unrestricted.
  6. If there is more than one type of account to purchase securities, ask what are the fees.  For example, is there a broker fee to buy and sell in-house or other mutual funds and is there an annual or quarterly account management fee?

There are also many different types of mutual funds.  The basic definitions of each type can be seen at http://www.bmoinvestorline.com/EducationCentre/MutualFunds/Reference_III.html

Although, it is true that one mutual fund will be safer than the other, there is no such thing as a risk-free guarantee fund.  For more information http://www.investopedia.com/terms/r/risk-freerate.asp will provide the details.

Bonds, go up in price when the interest rate drops and go down when interest rates go up.  Therefore, bonds also fluctuate with the market.  http://stocks.about.com/od/understandingstocks/a/Bondint111004.htm will provide the details.

Learn how to become an educated investor

Before jumping into purchasing securities without an advisor, I needed to figure out how to do it properly.  Therefore, I searched online for some free online courses.  Morningstar.com and Investopedia.com are two good resources that will help me become an educated investor.

Index tracking mutual funds

When it comes to purchasing index tracking mutual funds, they usually have a higher MER than ETF’s.  Furthermore, it is said that beating the market (index) is hard to do.  Therefore, index tracking mutual funds are a good investment for beginning investors.  Many are quite volatile, but at least one will know that by tracking an index, he/she will own a bunch of companies within that specific index.

Indexes usually consist of anywhere between 30, Dow Jones Industrial Average, up to 1000 or more securities such as the S&P Composite 1500.

Stock market index as defined in the Wikipedia at http://en.wikipedia.org/wiki/Stock_market_index

A list of indexes available to track can be seen at http://en.wikipedia.org/wiki/List_of_stock_market_indices

Hedge Funds

A fund that is out of reach for many average investors.  A hedge fund is commonly known as the fund available to the rich.

A hedge fund is unlike a mutual fund in many ways.  For a more detailed explaination,  http://www.magnum.com/hedgefunds/abouthedgefunds.asp and www.investopedia.com/terms/h/hedgefund.asp are good resources to start from.

In any case, it is best to look at the various options available.  Mutual Funds are no longer the only option available to average investors who would rather hire a professional to manage their investments.

Reading material

Morningstar’s webpage dedicated to Canadian mutual funds at http://www2.morningstar.ca/covers/fund_ca.aspx

Morningstar’s Mutual Fund screener tool is useful to find funds that match a specific criteria.  This screener can be used to find multiple funds that fit your needs.


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