How mutual funds help grow your savings
There are plenty of ways to save your money, but which one will help it to grow the fastest? If you put cash into a savings account, this could only bring you between 1% to 2% in interest, at best.
And while cash savings accounts are typically very safe, they’re not great for helping your savings grow fast, which is what you ideally want for long-term savings goals, such as your retirement.
To get average annual returns on your investments that are closer to 10% (a figure you need to achieve to have substantial growth) you’d typically need to invest in the stock and bond markets. Since 1971, the S&P 500 (the index that monitors the shares of the largest American companies) has delivered average annual returns of just over 10% over the last 50 years or so.1
For the average person, though, the stock market can be a scary place; which stocks should you choose, and how do you make sure you don’t lose your money? If you invest in just one company, or even one industry, and it goes under, you could lose most of your investment.
Investing in mutual funds can take away the risk of losing your money on just one stock. Let’s take a look at how mutual funds work, how they provide immediate diversification and why they can be a great choice for individual investors.
How do mutual funds work?
A mutual fund is a collection of assets (usually shares, bonds or a combination of the two) from a large number of companies and/or governments. Some mutual funds can contain hundreds of companies.
Mutual funds can contain companies from specific regions and industries, with different company sizes and types. They can also contain shares from companies within an index, such as the S&P 500 mentioned earlier, or the S&P TSX Composite Index (around 250 companies that trade on the Toronto Stock Exchange).
Investors see their money in mutual funds grow from:
- Interest (bonds typically pay a set interest rate)
- Capital gains (the increase in value of your shares)
- Dividends (some of the company’s profits, paid out to shareholders, usually four times a year)
Shares represent partial ownership of a company. Companies issue shares to generate money, which they usually use to fund growth. Often, companies pay out dividends (part of their profits) to their shareholders.
Bonds are a type of debt; investors lend companies (or governments) money, with the promise that it will be repaid with interest over a set time period.
The benefits of diversification
Mutual funds bring immediate diversification to your investments. Diversification is the practice of having a wide variety of assets in your portfolio, so as to reduce risk and lower volatility (which is when your investments’ value drops suddenly).
You also get to diversify by holding shares of hundreds of different companies, from a wide variety of regions and industries, and with a mix of shares and bonds.
They bring lower transaction costs
If you bought and sold many companies’ shares at once, you’d end up paying an awful lot in transaction costs. Buying one share in a company or 100 shares has the same transaction fee.
Mutual funds enjoy economies of scale; they have many transactions, not just for the initial purchases of shares, but also whenever funds are balanced. They pass those savings onto their investors.
Mutual funds are ideal for regular investors
Many investors like to save a set amount every month, like $500 or similar, which is possible with a mutual fund. This type of investing also helps you to take advantage of dollar cost averaging (an investing strategy that can help lower the average cost of shares bought and reduce the impact of volatility).
If you were buying individual shares, the total would rarely equal a round number, as you have to buy whole shares, not fractions of them.
Experts manage your investments for you
Most people don’t have the time or knowledge to buy individual shares. The amount of training and industry know-how required to successfully trade in stocks is something that very few amateur traders have.
Mutual funds are managed by investment professionals who have access to huge amounts of data and are trained in a wide variety of investment strategies. They’re able to pick shares that can deliver the mutual fund’s goals, such as copying the performance of an index or delivering above-average returns.
Mutual fund costs can vary
Mutual funds charge for this management expertise, and these costs are known as the management expense ratio (MER), which includes management fees and other expenses.
You won’t be billed for the MER; instead, the amount owed will be taken off the fund’s returns. You should check with your investment advisor to find out how much you’ll pay in MER for each mutual fund you invest in. The amounts can vary greatly.
Getting started with mutual funds
Cornerstone’s financial advisors can help you build up a portfolio of mutual funds that fit your personal investment goals and your risk tolerance. They’ll give you easy-to-understand advice in everyday language so that you can get your investments growing.
Call us at 1.855.875.2255 to book an appointment.
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We can advise you on the best mutual funds for your investment goals and risk tolerance.