"The stock market is designed to transfer money from the active to the patient." Warren Buffet
A mutual fund is a type of investment
Investors contribute their money to a mutual fund by buying units of the fund, and the portfolio manager invests the pool of money into stocks, bonds and other securities with the aim of giving investors a good return on their money. Investors own units of a fund, and do not directly own the stocks (or bonds, etc.) held by the fund. How much a unit is worth depends on the value of all of the stocks and bonds held in the portfolio. The value of a mutual fund unit changes in value every day that the stock market is open.
Many mutual funds are “actively managed”. This means the portfolio manager decides what to hold in the fund and can buy and sell securities at any time. It’s a highly discretionary task. Portfolio managers and the analysts working with them will do extensive research into companies and investments before making decisions about what to buy and sell. This is different than most ETFs, which often mirror an index, leaving little to no discretion to the portfolio manager. This is the main reason why ETFs have lower fees than mutual funds. For more on active vs. passive investing, see here.
What's to like
Easy to get invested
What's not to like
Fees charged are higher than ETFs and stocks
Many funds do not outperform the market
Potential for conflict of interest for saleperson
How can I use mutual funds?
You can use mutual funds to get very diversified exposure to the stock or bond market. By being diversified - owning many different stocks and bonds instead of just a few - you reduce the volatility or ups and downs in the value of your investments.
You can get exposure to many types of investments using mutual funds including Canadian, U.S. and international stocks and bonds, as well as commodities like gold. There are thousands of funds available in Canada.
Mutual funds are probably the easiest way to invest in the stock market. This is because you can buy them at your bank or credit union, through a financial advisor, and on a do-it-yourself investment platform. You can invest a small amount to start, and you can make regular contributions as small as $25 without a trading fee.
You can hold mutual funds in any kind of account including in an RRSP, RESP, TFSA and a regular, non-registered account.
Anything else I need to know?
Mutual funds charge a fee that is embedded in the fund. This is called the MER, or management expense ratio. It is expressed as a percent. For example, if a fund has an MER of 2%, you as an investor will pay 2% of the amount of money you have invested. You do not submit your payment of the fee to the fund company. Rather, the MER reduces the performance of the fund. This means if the stocks in a fund returned 8% in a given year, you will realize a 6% return on your money. Although this is convenient for you, it can make it feel like the fund is "free" to own, so it is important for you know the fund's MER.
MERs are higher than on ETFs. The active management you get the benefit of as a mutual fund investor comes at a cost. MERs vary greatly depending on the kind of fund it is, how it is sold, and who is managing it. Generally, MERs on equity funds are 1.0% to 2.5% per year.
It is a fact that more mutual funds underperform the overall stock market than outperform. In many cases, an investor is better off buying an ETF that mirrors the overall market (like the S&P 500) and avoid paying the higher fees charged by a mutual fund. Although this is a key argument for owning an ETF rather than a mutual fund, it is important to note that some mutual funds are managed to protect investors on the downside. For example, if the stock market goes down 10% in a year, the mutual fund might go down just 7%. This is because it is more conservatively managed. (On the flip side, if the market goes up 10%, the fund might go up just 7%). Generally, an ETF would not give this kind of downside protection.