Here's a comprehensive guide for financial advisors who want to help their clients pick the most suitable mutual funds for their portfolios
Picking mutual funds can feel overwhelming, especially for new investors. There’s a lot of information to sort through. But even when the facts are clear, many people still make choices based on emotions or common misunderstandings. That’s why it’s necessary to learn how mutual funds really work and what to watch out for.
In this article, Wealth Professional Canada will talk about the basics of mutual fund investing. We’ll discuss picking the right mutual funds, what to look for, and what to avoid.
What are mutual funds?
Mutual funds are investment products that pool money from many investors to buy a mix of assets. These assets can include stocks, bonds, cash, or a combination of them. Each investor owns units of the mutual fund. These units represent a share of the fund’s total holdings.
Mutual funds are managed by professional portfolio managers. These managers decide which assets to buy, hold or sell, based on the fund’s goal. For example, a growth fund might focus on stocks that have strong potential to increase in value. An income fund might invest in bonds that pay regular interest.
Mutual funds also come with fees, such as the Management Expense Ratio (MER). Financial advisors must be sure that their clients who want to build their portfolios are aware of these costs.
To learn more about picking mutual funds, watch this video:
Want to recommend smart choices to your clients who are interested in this type of investment? Check out the top 10 performing mutual funds in Canada in this article.
Types of mutual funds
Mutual funds come in different types. The two main types are:
- closed-end funds
- open-ended funds
Let's discuss them both below:
1. Closed-end funds
This type of mutual fund offers a fixed number of shares. Those shares will be sold to the public through an initial public offering (IPO). After that, the shares trade on the stock market. Investors buy and sell them like regular stocks.
The price of these shares changes based on supply and demand. Because of this, they often trade at a discount compared to the actual value of the fund’s assets.
2. Open-ended funds
This is the most common type. They do not have a fixed number of shares. Let’s put it this way, if your clients put money into the fund, the fund creates new shares. When your clients want to sell, the fund buys back the shares. The price is based on the current value of the fund’s assets. Most mutual funds in Canada are open-ended.
Financial advisors should consider the type and fee structure when advising their clients on selecting mutual funds.
Factors to consider when picking mutual funds
Choosing the right mutual fund is an essential part of building a portfolio for your clients. As a financial advisor, you want to make sure that the mutual fund that your clients pick matches their wealth-building plans and risk appetite.
Check out these factors when picking mutual funds:
1. Investment goal
When picking mutual funds, your clients should start by looking at what the mutual fund is trying to achieve. The mutual fund’s goal should match your clients’ needs. For example, a younger client saving for retirement might benefit from a growth-focused equity fund. On the other hand, an older and more conservative client might prefer a fund that offers a stable passive income with low risk.
2. Risk level
Every fund comes with some level of risk. Equity funds tend to have more ups and downs. Fixed income and money market funds are usually more stable. The right risk level depends on the investor’s age, timeline, and comfort with market changes.
Understanding how much risk your clients are willing to take will help narrow the mutual fund options.
3. Fees and costs
Mutual funds charge fees for management and operations. These can affect your client’s returns over time. Lower fees can lead to better results, especially for long-term investors. No-load funds, which don’t charge sales fees, might be a better option for some clients.
Your clients should also review the fund’s Management Expense Ratio (MER) and any sales charges. To understand how MER works, watch this video:
4. Fund manager’s track record
The main purpose of the person managing the fund is to allocate assets and produce returns for the investors. In turn, your clients must check how long the fund manager has been in charge and assess the performance of their past decisions.
A fund manager with a positive track record has a huge impact on the success of your clients’ mutual fund investment.
5. Diversification
A good mutual fund should be spread across different assets. This helps reduce risk, since the poor performance of one investment won’t hurt the whole fund.
Tell your clients to make sure that their chosen mutual fund will add something new to their portfolio. It defeats the purpose of diversification if it’s just the same as what they already have.
6. Tax impact
Some funds might lead to tax consequences, such as capital gains. If your clients are investing through a taxable account, think about how the mutual fund might affect their tax bill. You might want to suggest that they use more tax-efficient funds.
They could also place them in registered accounts like a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA) to reduce tax exposure.
Watch this for more information on investing in mutual funds:
If you're working as a financial advisor or aspiring to be one, having knowledge on picking mutual funds is an asset. Even knowing about cryptocurrency as an investment can be an advantage.
Points to remember when picking mutual funds
Investing in mutual funds can be a great way for your clients to grow their money. However, it’s critical for them to set their expectations based on expert opinion. Their choice should also be backed by facts. Just because a fund did well in the past or has a star manager doesn’t mean it will keep performing that way. Factors like high fees and hidden biases can all lead to poor investment strategies.
It’s also worth thinking about one’s values and goals. The right choice really depends on your clients’ preferences and plans for their finances. In the end, advise them not to make hasty decisions and do their research when picking mutual funds.
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