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Are funds risky?
It’s impossible to compare funds “across the board”. Mutual funds not only differ in their financial objectives but also invest in different kind of securities that reflect the ultimate objective of the fund. Thus, depending on the securities the fund is investing in, or the mix of securities chosen for a specific fund, the element of ‘risk’ varies substantially.
The fund’s objective is what the fund seeks to achieve by investing. This will determine what kind of securities the fund will buy, and in what economic sectors or countries.
For example, a fund seeking the highest possible return on capital may invest in more speculative common stocks than one seeking maximum income from dividends. The risk in the first objective is much higher than in the second.
You can see, therefore, that the amount of risk involved is directly related to the fund’s objective. Generally speaking, it can be assumed that the higher the return, the higher the risk involved.
However, mutual funds remove much of the risk from investing because they are professionally managed by fund managers with many years experience in portfolio management. For example, in common stock funds, professional managers select the investments and monitor them carefully and
constantly. In addition, because of the ‘pooled’ concept inherent in funds, the element of risk is spread, thereby making funds less vulnerable to market fluctuations.
It should also be remembered that while it may be considered ‘safe’ to keep one’s savings in cash, there is always the risk that inflation will, over time, erode the value of those savings.
3. How do the rates of return offered in funds compare with savings accounts?
Generally speaking, savings accounts are the means by which banks and trust companies borrow money from the public and lend it to companies and individuals at higher rates. The financial institution makes money on the spread or the difference between the rate it pays on savings accounts and the rate it charges borrowers. A money market mutual fund, for example, lends money directly to governments, corporations, and financial institutions and all people who invest through such funds earn the higher rate. There is no middle man.
The rates of return of return for “non-guaranteed” investments, such as common stock funds have, over time, historically been much superior to that of a savings account with a financial institution. This is because, in a free enterprise system investors who choose to “share” ownership of a public business by purchasing common shares are sharing in the fortunes of the business. If it does well they share profits – if it does badly there are little or no profits to share. They therefore expect, and get, a higher return for taking this risk. However, it must be borne in mind that the return on a common stock fund would not necessarily be consistent from year to year as companies do better in some periods than others.
How has the fund performed?
Past performance can’t tell you how the fund will perform in the future. But it can give you an idea of how the fund compares to other funds with the same investment objective. Don't just look at how the fund performed last year. How consistent has it been over the long term? How has it performed in different market conditions? If the fund’s investment objective has changed in recent years, its past performance will be even less of a reliable predictor of its future performance.
4. What are the fund's costs?
All funds must disclose their fees and expenses in their Fund Facts document and simplified prospectus. Consider all of the costs. For example, a fund with a low management expense ratio (MER) could have very high sales charges, and vice versa. Understand what you'll pay when you buy or sell units of the fund. Also consider what you’re getting for your money. What level of service and advice will you receive?
Who manages the fund?
The success of a mutual fund depends on the portfolio manager’s skill at choosing investments, and knowing when to buy and sell them. What kind of education and experience does the portfolio manager have? Does the manager run other funds? How successful have they been? What is their investment style? Find out how stable the fund's management has been over the years. High turnover can be a warning sign.