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FAQ

Why invest in mutual funds?

When you buy a mutual fund, you’re pooling your money with many other investors. This lets you invest in a variety of investments for a relatively low cost. Another advantage is that a professional manager makes the decisions about specific investments.

Also, mutual funds are widely available through banks, financial planning firms, brokerage firms, credit unions, trust companies and other investment firms. You can buy or sell funds at any time.

Other things to consider

Like all investments, mutual funds have risk— you could lose money on your investment. The value of most mutual funds will change as the value of their investments goes up and down. Depending on the fund, the value could change frequently and by a lot. Also, there are fees that will affect the return you get on your investment. Some of these fees are paid by you, and others are paid by the fund.

The importance of diversification

Mutual funds can make it easy and affordable to own a variety of investments. Not all investments perform well at the same time. Different investments react differently to world events, factors in the economy like interest rates, and business prospects. So when one investment is down, another might be up. Having a variety of investments can help offset the impact poor performers may have, while taking advantage of the earning potential of the rest. This is called “diversification.”

What’s a benchmark?

Typically, a benchmark is a market or sector index against which the performance of the mutual fund can be measured. For example, if a fund invests mainly in Canadian stocks, the benchmark might be the S&P/TSX Composite Index, which tracks companies trading on the Toronto Stock Exchange.

By comparing a fund to an appropriate benchmark, you can see how the investments held by the fund performed compared to the market or sector in general.

Type of fund & What it mainly invests in

Money market - Short-term fixed income securities like treasury bills

Fixed income - Fixed income securities like government bonds and corporate bonds

Growth or equity - Equities like stocks or income trust units

Balanced - A mix of equities and fixed income securities

Global - Foreign equities or fixed income securities

Specialty - Equities or fixed income securities in a specific region (for example, Asia) or sector (for example, information technology)

Index - Equities or fixed income securities chosen to mimic a specific index, such as the S&P/TSX Composite Index

Fund of funds - Other mutual funds

How can you make money?

You’ll make money on a mutual fund if the value of its investments goes up and you sell the fund for more than you paid for it. This is called a capital gain. If you sell the fund for less than you paid for it, this is called a capital loss.

Depending on the fund, you may also receive distributions of dividends, interest, capital gains or other income the fund earns on its investments. However, unless you ask for the distributions to be paid in cash, the fund will usually reinvest them for you.

Fund performance

How a fund has performed in the past can’t predict how it will perform in the future. However, it can give you an idea of how the fund has performed in different market conditions. It can also give you an idea of how the fund compares to:

• other funds with the same investment objective

• a relevant benchmark

You can find performance information in the annual and semi-annual performance reports that mutual funds must issue. These reports are called “management reports of fund performance.” They include the fund’s returns for various periods and a discussion about what affected the fund’s performance in the past year.

Management reports of fund performance are available from the fund company and on www.sedar.com . Mutual funds are required by securities law to file these reports and other documents on the System for Electronic Document Analysis and Retrieval (SEDAR).

You can also find other performance information on the fund company’s website, in major financial newspapers and on websites like www.globefund.com or www.morningstar.ca .

How mutual funds are taxed

In general, you’ll have to pay tax on the money you make on a fund. Interest, dividends and capital gains are all treated differently for tax purposes and that will affect your return from an investment. Keep in mind that distributions are taxable in the year you receive them, whether you get them in cash or they are reinvested for you.

However, if you hold your mutual funds in a registered plan, you won’t pay income tax on the money you make as long as that money stays in the plan. When you withdraw money from the plan, it will be taxed as income.

Registered plans include:

• Registered Education Savings Plan (RESP)

• Registered Retirement Income Fund (RRIF)

• Registered Retirement Savings Plan (RRSP)

You may want to talk to a qualified tax expert about any taxes you may have to pay on your investment in mutual funds.

What are the risks?

Most mutual funds are not guaranteed—you could lose money on your investment. The level of risk in a mutual fund depends on what it invests in. For example, stocks are usually riskier than bonds, so you would expect an equity fund to be riskier than a fixed income fund.

Keep in mind that all investments have risk. The key is to understand the risk involved and decide if you’re comfortable with it. You can help minimize your overall risk by owning a variety of investments. So before you decide on a mutual fund, think about how it fits with the rest of the investments you own .

Common types of risks

1. Country risk - Foreign investments

The value of a foreign investment declines because of political changes or instability in the country where the investment was issued.

2. Credit risk - Fixed income securities

If a bond issuer can’t repay a bond, it may end up being a worthless investment.

3. Currency risk - Investments denominated in a currency other than the Canadian dollar

If the other currency declines against the Canadian dollar, the investment will lose value.

4. Interest rate risk - Fixed income securities

The value of fixed income securities generally falls when interest rates rise.

5. Liquidity risk - All types

The fund can’t sell an investment that’s declining in value because there are no buyers

6. Market risk - All types

The value of its investments decline because of unavoidable risks that affect the entire market.

How is your investment protected?

Mutual funds are not covered by the Canada Deposit Insurance Corporation, the Autorité des marchés financiers’ fonds d’assurance-dépôts (Québec) or other deposit insurance. However, there are some safeguards in place to help protect investors.

For example, a mutual fund’s assets must be held separately by a third party called a custodian. This is usually a chartered bank or trust company. Also, an independent auditor reviews and reports on the fund’s financial statements each year.

If a firm goes bankrupt There are two funds in place that may help protect your investment if the firm you dealt with goes bankrupt.

Canadian Investor Protection Fund (CIPF)

CIPF provides protection of up to $1 million to eligible customers of a member firm. For more information, see www.cipf.ca .

MFDA Investor Protection Corporation

The Mutual Fund Dealers Association of Canada (MFDA) has an investor protection fund called the MFDA Investor Protection Corporation (IPC). The MFDA IPC provides protection of up to $1 million to eligible customers of MFDA members.

For more information, see www.mfda.ca .

What are the costs?

Sales charges

Sales charges are the commissions that you may have to pay when you buy or sell a fund. If you pay this charge when you buy the fund, it’s called an initial sales charge or front-end load. If you pay it when you sell, it’s called a deferred sales charge or back-end load. Some funds are sold on a “no-load” basis, which means you pay no sales charge when you buy or sell.

Comparing sales charge options

With initial sales charges, the cost can vary from firm to firm and may be negotiable. Shop around, and remember that every dollar you pay in commission is a dollar that does not go to work for you in the fund.

With deferred sales charges, the fee you’ll pay is set. There’s no negotiation. Also, you’ll be locked into a fund family for a few years unless you’re willing to sell the fund and pay a sales charge. And while you won’t pay a sales charge on a no-load fund, it still has other costs like management fees and operating expenses.

Management expense ratio (MER)

Each mutual fund pays an annual fee to a management company for managing the fund and its investments.

Mutual funds also pay their own operating expenses. These include legal and accounting fees, custodial fees, bookkeeping costs and other expenses. Some mutual funds pay a fixed administration fee to cover their operating expenses.

The management expense ratio (MER) is the total of the management fee and operating expenses. It’s shown as a percentage of the fund’s assets. For example, if a $100 million fund has $2 million in expenses for the year, its MER is 2%.

You don’t pay management fees or operating expenses directly. These expenses affect you because they reduce the fund’s returns—and what you get on your investment.

What’s a simplified prospectus?

A simplified prospectus is a document that firms are required to send to investors after they buy a fund. You can also ask for a copy of the simplified prospectus before you invest. It includes information about a fund’s:
• investment objectives and strategies
• risks
• suitability for certain investors
• distributions
• sales charges, management fees and operating expenses
• income tax considerations

Trailing commission

In general, the management company pays a portion of its management fee to the firm you dealt with as a trailing commission (or trailer fee). This commission is for the services and advice the firm provides to you.

It’s usually based on the value of your investment and is paid for as long as you own the fund. Firms may pay a portion of the trailing commission to their advisers.

Questions to ask before you buy

Find out as much as you can about a fund before you invest. Read documents like the simplified prospectus and management reports of fund performance. Also take the time to research the fund in major financial newspapers and on websites like www.globefund.com and www.morningstar.ca .

Find out things like:

1. What is the fund’s goal? Make sure the fund’s goal fits with your investment goals. Does the fund provide regular income? Does it provide the level of return you’re looking for? Does it fit with your time horizon? Does it work with your other investments?

2. How risky is the fund? Remember that you can make or lose money on a mutual fund. Can you accept the fund’s level of risk?

3. How has the fund performed? Although past performance can’t predict future results, it can give you an idea of how the fund compares to other funds with the same investment objective.

4. What are the fund’s costs? All funds must disclose their fees and expenses in their simplified prospectus. Consider all of its costs. For example, a fund with a low MER could have very high sales charges, and vice versa. Also consider what you’re getting for your money. What level of service and advice will you receive? Finally, compare the fund’s costs and performance against similar funds to see what kind of value you’re getting.

5. Who manages the fund? The success of a mutual fund depends on the portfolio manager’s skill at choosing investments. What kind of education and experience does the portfolio manager have? Does the manager run other funds? How successful have they been?

6. How will you be taxed? If you don’t hold the fund in a registered plan, do you know what types of distributions are usually made and how they’re taxed? Do you know how capital gains (or losses) are taxed?

What are the advantages of investing in a mutual fund?

Diversification

Investing in different securities helps reduce the risk related to investments. When you invest in a mutual fund, you buy an interest in a portfolio made up of a multitude of different securities. This gives you instant diversification, at least within the type of securities held by the mutual fund. When certain conditions are met, diversification considerably reduces the risk, even if the investments may be risky individually.

Accessibility

For many mutual funds, you can begin to buy units with a relatively small sum, such as $ 500 for the initial purchase. Certain mutual funds also allow you to purchase units regularly through even smaller instalments, such as $ 50 per month.

Portfolio management

Investors seldom have the time and resources to conduct research on securities. The task of managers consists of identifying the best opportunities and diversifying investments, according to the objectives of the mutual fund.

Liquidity

The vast majority of securities held in the portfolio of a mutual fund must be easily traded so that the units can be redeemed at any time. The proceeds of redemption are therefore generally payable on very short notice.

Flexibility

Many mutual fund management companies handle several different mutual funds. It is sometimes possible to make transfers free of charge between mutual funds of the same family. For example, a family of mutual funds could offer money market, fixed income, equity, balanced and international mutual funds. It may also be possible to automatically reinvest income and capital gains for the purchase of additional units.

Monitoring of return

The value of most mutual funds is published daily in the financial press and on many websites. This allows you to regularly monitor the return on your investment.

Administration

Administrative duties, including bookkeeping, the preparation of tax information and the reinvestment of distributions (income from various sources and capital gains earned), are performed by the mutual fund manager or entrusted to a third party.

What are the disadvanatges of investing in a mutual fund?

Most mutual funds focus on long-term investments. They are not suitable for investors who are looking for a short-term return and who want to trade often. In addition, as we will see in the following section, some mutual funds charge fees on every transaction.

It is not recommended that mutual funds be used as a source of emergency funds. An investor could have to ask for units to be redeemed during a market downturn and thus incur a loss.

How do you know if mutual funds are suitable for you?

For most investors, choosing a representative and a firm constitutes the first step in any investment program. For further details, see the brochure entitled Choosing a securities firm and representative . With the help of your representative, you can establish your investment objectives, assess your risk tolerance and develop a personal investment strategy.

Ask your representative whether mutual funds are an appropriate investment for you. Discuss the type of mutual fund that best meets your personal investment strategy and then ask for some suggestions.

Once you have identified a few mutual funds that seem to meet your needs, read the prospectus for each of them. Pay special attention to the following points:

Investment objectives

Are the mutual fund’s investment objectives compatible with yours? Can the mutual fund give you the level of regular income you need? Does it provide you with the type of diversification you are seeking?

Risk

Do you feel at ease with the degree of risk associated with the mutual fund? If you hold other investments, will the mutual fund have the effect of increasing or reducing your general exposure to risk? As mentioned, mutual funds are not insured by deposit insurance. The value of most mutual funds fluctuates. You could therefore incur losses depending on market conditions.

Time horizon

Does the investment fit into the time horizon you have planned for your investments? For example, if you invest for a relatively short period, will the front load and back load fees (if any) cancel out your potential gains? Could the value of the mutual fund have dropped when you need to redeem your units?

Expected return

Is the mutual fund able to provide the return that will enable you to reach your goals? The past performance of a mutual fund will give you information about historical fluctuations and could be compared with competing mutual funds. However, this is not a reliable indicator of future returns. The return you expect to earn from a mutual fund is closely linked to any associated risk. The lower the risk associated with a mutual fund, the lower the expected return. Make sure your expectations are realistic.

Flexibility

Will you have the right to transfer your investment to other mutual funds belonging to the same “family”? Can you afford to make the minimum initial investment? Does the mutual fund offer other advantages, such as a regular monthly subscription or redemption plan you might be interested in?

Tax consequences

If you invest in a mutual fund outside a registered plan, are you aware of the tax related to the fund’s distribution of income or capital gains? As a general rule, a mutual fund will distribute enough of its income and capital gains each year to avoid being taxed on its profits. This means that you will have to pay tax on the income allocated to you. When you ask for your mutual fund units to be redeemed, you will have to declare any capital gain (or loss).

If you hold your investment through a registered plan, the income or capital gains attributed to you are generally not taxable, provided they are held in your registered plan, but as soon as you redeem units or cash distributions from your registered plan, you are taxed at the applicable tax rate, as you would be for any income.

If necessary, ask your representative about the tax consequences of investing in a mutual fund. Carefully read any information provided by the mutual fund in this respect.

For more information

Our free, objective guides can help you learn more about investing and how specific investments work. They’re available on the Canadian Securities Administrators website at www.securities-administrators.ca or by contacting your local securities regulator.

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