A mutual fund is a professionally managed investment portfolio that combines the money of many investors and invests it in stocks, bonds, and other securities. When you buy a share in a mutual fund, you are effectively buying a part of each security that is held in the mutual fund’s portfolio.

Individuals invest in mutual funds because they are a convenient and cost effective way to obtain professional investment management and portfolio diversification.

Mutual funds offer:

Professional Management: Investors of any size or experience can access the specialized skills of experienced portfolio managers and their team of researchers.

Diversification: Since mutual funds are by definition a portfolio of securities, they allow investment risk to be spread out over a number of industries and companies, thereby reducing risk. In addition, due to the many types of mutual funds available, eg. equity funds, fixed-income funds, foreign funds, financial sector funds, etc. you can also obtain diversification amongst asset classes, industries, geographic regions and investment styles.

Affordability: You can invest in most mutual funds for as little as $500.

Liquidity/Convenience: You can place orders to buy or sell a mutual fund by phone or through the internet with your broker such as BMO InvestorLine. In the case of a sale, the sale proceeds are available generally on the third business day after the transaction date.

Performance Monitoring: The performance of mutual funds is readily available online and in the print media, thereby making it easy for you to follow your investment progress and make comparisons between funds.

Choice: There are many mutual funds available, each with its particular investment objectives and characteristics. BMO InvestorLine’s Mutual Funds Online gives you the tools to help you research, sort, and group over 9,200 funds to find the ones that meet your investment criteria.

Dollar Cost Averaging: Though some people make lump-sum mutual fund purchases of $5,000 or $25,000, you can also choose to purchase smaller amounts over regular intervals, such as every month or every quarter. This periodic purchase is known as dollar-cost averaging and is a good way to invest. Given that you invest the same dollar amount every month, when the market declines you will be buying more mutual fund units thus lowering your average cost. Conversely, when the market rises, you will be raising your average cost. If you are investing for the long term, this is one of the best ways to save and invest.

What you pay for the benefit of professional management and how your investment income from a mutual fund is taxed are both important issues to consider when investing in mutual funds.

Mutual Fund Expenses: All mutual funds charge expenses which can cover everything from paying the investment management fees to brokerage commissions to marketing expenses. When comparing expenses amongst different funds, you can use the Management Expense Ratio or MER. These expenses are charged to the fund before performance is reported.

Mutual Fund Taxation: Mutual funds can invest in a variety of securities such as stocks, bonds and other investments that generate different types of income, such as dividends or interest, for the fund. In addition, the buying and selling of securities within the mutual fund portfolio generates capital gains and losses. Any income earned and any capital gains/losses that have been realized are distributed to the investor and must be declared as investment income, even if you have not sold any of your mutual fund units.

As a mutual fund investor then, tax planning may be difficult as you have no control over the timing of investment purchases or sales by the fund and accordingly, when you may have to pay taxes. Of course, if you hold mutual funds inside an RRSP, your investment income is sheltered from taxation during the life of the RRSP plan. You will not have to pay tax until you decide to take money out of your RRSP to fund your retirement.

NAV or Net Asset Value, is the value of all the securities held by the mutual fund calculated at the closing market prices at the end of each business day. NAVPS, or Net Asset Value Per Share is the NAV divided by the number of units outstanding in the mutual fund and is the unit price you would have paid for the fund had you bought it that day.

When you make a purchase in a mutual fund, you do not know what price you will be paying per unit since the market prices of securities held in the fund fluctuate throughout the day. For example, an investor may place an order to buy $1000 worth of a fund and will only find out after the unit price is calculated after the market closes, how many units were purchased. Once you know the number of units you own in a fund, multiply that by the NAVPS and you can calculate the value of your investment on an ongoing basis.

For example, you bought $2000 worth of First Canadian Dividend Fund on Monday. The closing price on Monday was $18.27, hence you own 109.469 units. Two weeks later you see that your fund closed at $18.35, your investment is now worth $2008.76 ($18.35 x 109.469).

A closed-end fund is issued with a fixed number of shares and they generally trade on a stock exchange. As with stocks, to purchase a unit of a closed-end fund, you would be buying from a seller and vice versa if you were selling. In addition, you would pay brokerage commissions on both transactions.

Most of the mutual funds available are open-end funds which means that there is no limit on the number of units the fund can sell, and the fund will always redeem units you hold upon your instructions. Generally, investors purchase open-end funds directly from the mutual fund company or through a mutual fund distributor. The distributor can be your full-service broker, your financial planner, the fund company itself or a direct investing firm such as BMO InvestorLine.

Open-end funds may sometimes be closed to new purchasers because the fund managers believe that the current size of the fund is optimal to manage and to maintain investment performance.

If you want additional information, you can ask the fund company for their Annual Information Form or the fund’s Annual or Semi-Annual Report.