What is a mutual fund?

Like Beanie Babies, mutual funds first soared in popularity in the 1990s. Guaranteed Investment Certificate investors sought higher returns as interest rates fell and looked to mutual funds instead. Today, unlike the plush toy craze, mutual funds remain in demand. In fact, they're the primary investment vehicle for Canadians. At the end of June 2024, we had more than $2.073 trillion invested in mutual funds (compared to just $440.5 billion invested in exchange-traded funds, aka ETFs).

Are mutual funds right for you? Keep reading for an overview of what you need to know about mutual funds so you can make an informed investing decision.

Mutual funds: a definition

A mutual fund is a professionally managed pool of investments that typically hold stocks, bonds, or money market securities. It uses the collective buying power of many investors to build a diversified portfolio that would otherwise be too expensive or unwieldy for an individual to manage on their own. 

When you invest in a mutual fund, your contributions — no matter how big or small — go into the professionally managed investment pool. When those collective assets rise or fall in value, your share of the fund will also increase or decrease in value.

Unlike stocks or ETFs, which can be bought and sold anytime during trading hours, mutual funds are only priced once a day. At market close, the mutual fund is worth the net asset value of all its shares.

Mutual funds can be classified as equities, bonds, or balanced funds (which invest in a mix of stocks and bonds). Each fund is managed by a professional who sets its objectives and makes investment decisions. Some mutual funds passively track a specific market index and don’t require active decision making from a professional manager.

Types of mutual funds

Mutual funds come in a wide variety of flavours — there are more than 5,000 mutual funds to choose from in Canada!

Equity mutual funds hold shares of publicly traded companies. They are a core holding for long-term investors. You can find equity mutual funds focusing specifically on Canadian stocks, U.S. stocks, international stocks, and emerging markets. Equity mutual funds can also specifically target shares in large, mid-sized, or small companies.

Bond mutual funds, also known as fixed-income mutual funds, are a core holding for long-term investors. This category includes short- and long-term government bond funds, aggregate bond funds, corporate bond funds, and more. Since bonds are considered more stable than stocks, holding a bond fund in a portfolio can help reduce its volatility — or narrow the range of possible outcomes — while regular interest payments can provide income for investors. They can also be reinvested in the bond fund for compound returns.

Balanced mutual funds combine equity and bond funds into one easy-to-manage product. They’re an ideal solution for medium-risk investors. The most common is a global balanced fund, which offers investors a one-stop investing solution that includes roughly 50% stocks and 50% bonds from all over the world.

Specialty mutual funds invest in certain sectors or themes, such as science and technology, oil and gas, biotech, cannabis, and more.

Money market mutual funds invest in highly liquid cash and cash equivalents, such as short-term government bonds or treasuries.

Index funds are mutual funds that passively track a particular market index with the goal of closely matching its return. Index funds could fit into any of the above categories. However, they use a passive, rules-based approach to investing rather than a fund manager actively making investing decisions.

What fees are associated with mutual funds?

Mutual funds charge fees expressed as a Management Expense Ratio (MER). By law, funds must publish their MER, and investors can find the costs listed in the fund facts document. 

The MER is the total of the fund's management fee, plus trailing commission paid to the mutual fund dealer representative or advisor, administration fees, and other expenses.

Let’s look at the fee breakdown of a typical Canadian equity mutual fund in more detail:

^{Fees provided are from Morningstar Global Investor Experience Study, 30 March 2022.}

Expressed in dollar terms, if an investor had $100,000 invested in a mutual fund with a 2.25% MER, they would pay $2,250 per year in fees.

It’s important to note that a mutual fund’s returns are published after fees and expenses have been deducted. This is the net return.

Tangerine’s suite of Core Portfolios charges a reasonable MER of 1.06%¹, while its Global ETF Portfolios and Socially Responsible Global Portfolios have an MER of 0.76%¹ and 0.82%¹, respectively. These are all well below the average MER of 1.47% for mutual funds in Canada as of 2023².

Pros and cons of mutual funds

Mutual funds sometimes face criticism in Canada thanks to their generally high overall fees compared to index funds and ETFs. But fees do vary from fund to fund, so it helps to do some research before investing. If used properly, mutual funds can be an incredibly effective tool for investors to build a portfolio.

Pros

• No commission to buy and sell – Unlike stocks and ETFs, which typically come with trading fees (usually around $10 every time you buy or sell), investors don’t typically pay trading commissions when they buy and sell mutual funds. This can be an advantage for new investors adding small, frequent amounts to their RRSP or TFSA. Some funds, including those at Tangerine, allow investors to automatically add a set amount of money to their portfolio on a regular basis.
• Instant diversification – Mutual funds are a pool of investments that give investors access to broad diversification even with a small amount of money. No matter whether you contribute $100 or $10,000, that money is spread out among all the fund's underlying investments. This diversification is why mutual funds are considered less risky than putting all your money in a single stock.
• Access to professional fund managers – While most actively managed mutual funds don’t beat the market over long periods of time, some fund managers do have a strong track record of beating their benchmark. Besides, having a professional manage your portfolio means you don’t have to play an active role in buying, selling, or building your portfolio.

Cons

• High management fees – Canadian mutual funds charge some of the highest fees in the world, although those fees have been on the decline in recent years, to an average MER of 1.47% in 2023. Conversely, passively managed index-tracking mutual funds and ETFs, such as Tangerine's Investment Portfolios, tend to charge considerably less for a similar, diversified portfolio.
• Underperformance – High fees are a drag on performance, so it’s no surprise that most actively managed mutual funds fail to keep up with their benchmark index. An incredible 97 percent of Canadian equity mutual funds underperformed the S&P/TSX Composite index over a 10-year period.
• Difficult to purchase on your own — Canada’s big banks sell mutual funds through their vast network of bank branches. Self-directed investors looking to buy index funds need to insist on these lower-cost products at their bank, or else open a discount brokerage account and purchase index funds on their own.

Evaluating mutual funds

There are thousands of mutual funds available in Canada. How do you decide which one(s) are suitable for your portfolio? Your advisor will work with you to create an investor profile to determine your risk tolerance and time horizon. This assessment will help determine a suitable mix of stocks and bonds to hold.

How to determine your asset allocation

Your asset allocation will depend on a number of individual factors unique to you. More risk-averse investors, or those expecting to spend their investments relatively soon (such as people nearing retirement), may want a less aggressive portfolio and, therefore, may want a higher allocation of bonds. 

A sample mutual fund-based portfolio

Once you’ve decided on an appropriate asset mix, you need to determine how to allocate your investments across various asset classes, industries, and geographical regions to diversify your portfolio.

For example, let’s say you’re a young investor who wants to invest in a growth portfolio of 80 percent equities and 20 percent bonds. On the equity side, as an example, you might consider allocating a portion of your portfolio to Canadian stocks, U.S. stocks, and international stocks to represent a globally diversified pool of stocks. On the fixed-income side, you may want to hold a Canadian aggregate bond mutual fund comprised of government and corporate bonds. Here's a breakdown of what you might want your portfolio to include:

• Canadian equities: 20%
• U.S. equities: 40%
• International equities: 20%
• Canadian bonds: 20%

How to choose the right mutual funds for your portfolio

Now that you know what type of portfolio you want to build, you can begin evaluating mutual funds. Fees are a key predictor of future returns. That means when comparing similar mutual funds, consider leaning towards one with a lower fee or MER.

You can also look at performance history, although this comes with the typical caveat that past performance is not indicative of future returns. Past performance, particularly over a five- or 10-year period, can reveal whether a mutual fund manager consistently outperforms their benchmark. It can also show how well the fund has performed compared to similar funds in its category.

The investment research firm Morningstar is an excellent source for comparing and evaluating mutual funds. Prospective investors can screen for low fees, short-term performance, and long-term performance, as well as by Morningstar’s own five-star rating system. 

At the individual fund level, investors can dig into a fund’s profile to see how it stacks up against its benchmark index and its category peers. You can also find the fund’s fees, if there’s a minimum initial investment, and how well it has performed over a 10-year period.

Are mutual funds risky?

In many ways, risk in the eye of the beholder. Any investment that is not held in cash or guaranteed investment certificates will carry some risk of decreasing in value, and mutual funds are no different. 

Typically, a fund with higher volatility will have returns that change more over time. This could mean a greater chance of losing money, but it could also mean the potential for higher returns.

Meanwhile, a fund with lower volatility will have returns that change less over time. These funds will have lower returns and may have a lower chance of losing money.

Mutual funds are required to publish a fund facts document and show the risk rating of the mutual fund, such as low, low-to-medium, medium, medium-to-high, and high. For instance, the Tangerine Dividend Portfolio had a "medium" risk rating as of April 1, 2024, while the Tangerine Equity Growth Portfolio had a "medium-to-high" risk rating as of October 30, 2024. Just know that a fund with a low-risk rating can still lose money. 

Mutual funds benefit from their size and scale, with the ability to diversify across a large number of securities. This helps reduce the particular risks involved with investing in a single security.

But mutual funds can — and do — lose money over the short and long term depending on how well their underlying holdings perform. Stocks, in particular, are volatile by nature and can have negative performance over certain periods of time.

A mutual fund investing in a specific sector, such as oil and gas or technology, is riskier than a fund that invests in stocks from large, well-known companies. The large stock fund, in turn, is riskier than a balanced fund containing many stocks and bonds.

Finally, as we know, past performance does not guarantee future results. 

Do mutual fund fees matter?

We know that Canadian investors may pay some of the highest mutual fund fees in the world. That statement can make all mutual funds sound like a bad deal. But that’s not true.

As we’ve discovered, there are thousands of mutual funds to choose from in Canada. Some of these funds are index funds, which cost about half as much as their active fund counterparts.

While it’s difficult for an active fund manager to beat the market over time, several solid mutual funds with a long track record of strong performance are available in Canada. 

While past performance may show a fund manager’s persistence and skill, it’s no guarantee of future results. Fees matter. 

Final word

Mutual funds are the investment vehicle of choice for Canadians due to their convenience and wide mainstream availability.

With many financial institutions, you can start investing with as little as $25 to $50 per month. Investing in mutual funds is also highly cost-effective since, unlike stocks and ETFs, there are no transaction costs to buy and sell a typical no-load mutual fund.

However, be mindful of fees. Before you make that purchase, do some research to find a fund with a strong track record, a risk profile you're comfortable with, and competitive fees.

¹ A fund's expenses are made up of the management fee (including the trailing commission), operating expenses, trading costs, and fixed administration fee. The annual management fee is 0.80% of each Tangerine Core Portfolio, 0.50% of each Tangerine Global ETF Portfolio, and 0.55% of each Tangerine Socially Responsible Global Portfolio. The fixed administration fee is the same for all Tangerine Portfolios and is 0.15% of each Portfolio’s value.

² According to a survey by the Conference Board of Canada in September 2024.