Navigating Financial Funds: A Guide for Smart Investments

Why Funds?

It would take pages to fully explain funds, so here’s my brief summary. Owning a large assortment of individual stocks and bonds is a low risk way to aim for the best long term returns from the stock market.

Unfortunately setting up this type of portfolio traditionally required a large amount of money. By pooling many investors money, companies created affordable solutions for investors who wanted these products. Thus was born the modern concept of a fund, which typically includes a mix of stocks and bonds.

Banks and financial institutions embraced this concept and in the late 1980’s an explosive growth of funds resulted. Naturally this led to a great deal of choices and confusion when it came to selecting a fund.

The two biggest considerations regarding selecting a fund are the fees and management.

1) Fees:

When it comes to fees I always insist on no commissions, service charges or other loads. You will have to pay a management fee (usually called a management expense ratio – MER), which I insist be at industry low levels. The funds I currently own have annual fees at or near 0.2%. I still don’t understand the fee structures associated with some funds, mainly because they are too high and I refuse to use them.

Note: Annual management fees are based on the amount you have invested, not on the gain for the year. Whether the fund goes up or down, the management expense must be paid.

2) Management:

A fund can be managed by a set of rigid rules which are strictly followed. These are called passive funds. The “rules” might be to follow a predetermined allocation of stocks to bonds, international to domestic stocks, stock percentages associated with a particular stock exchange (index funds), or specialty arrangements. The main point is that decisions are reduced to following rigid rules allowing fees to be kept low.

Active vs Passive Funds

Funds that have managers who make all the decisions are referred to as active (as opposed to passive). Typically these funds promote a superstar manager who will presumably deliver better performance. History shows us that this is rarely the case, and the winning managers change on a yearly basis.

Studies show that funds with high fees and active management consistently underperform their counterparts. Simply put, always aim for passive funds with low fees.

What’s out there:

Mutual funds:

these have been around a long time and I have no love for them. High fees, active management, and lagging performance are common.

Bond funds:

a fund that holds bonds. These funds can focus on government bonds, company bonds, or high risk bonds.

Index funds:

these funds track the components of a financial market index. This provides broad exposure across a single stock market such as the Toronto Stock Exchange (TSE) or the New York Stock Exchange (NYSE).

Exchange traded funds (ETF’s):

an investment that trades on an exchange (like the TSE) and consists of an assortment of stocks and bonds. These funds commonly include several index funds as well as bond funds and are basically “funds of funds”. These are my funds of choice due to the low fees and great diversification.

Specialty funds:

these include just about anything you can think of.

Do you like dividends – there are dividend reinvestment plans (DRIPS).

How about real estate – real estate investment trusts (REITS).

Concerned about the environment – low carbon ETF’s.

From marijuana to precious metals there’s a fund out there. Remember, the more specialized the fund the less the diversification, the higher the fee, and the greater the risk.

The bottom line:

I aim for funds with low fees and passive management and ETF’s are my choice. I had mutual funds for years and was disgusted by their poor performance and high fees. so, I systematically cashed them in for well diversified low fee ETF’s and I’ve never looked back. Since ETF’s aim for market average performance with low fees and simple rules based management, they perform well in the up cycles and weather the downturns. It’s my long term strategy.

In my E-books (“Water Barrel” and “The Balance”) I discuss simple methods to live sensibly for today, take charge of your financial affairs, and invest safely for the long term. For more information please visit David Penna Amazon.

As always, I am not a qualified financial advisor. I just relate financial management to my own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of mine came from expensive experiences.