Mutual Funds Held Inside TFSA’s
Mutual funds are a very popular investment for the average person deciding on a TFSA portfolio. In the past they were considered the best way for investors to access securities otherwise unavailable on an individual basis. Nowadays with the rise of Exchange Traded Funds (ETFs) which offer the same benefits, this is no longer the case.
Management Expense Ratios
By definition, mutual funds exist due the pooling of financial resources by many investors. The drawback of this system is that it requires significant operating expenses on the part of the banks (a portfolio manager oversees the fund), which are passed on to you along with the banks’ commission fees. This management expense ratio (MER) can quickly eat into your returns, especially if markets are down.
Types of Mutual Funds
When deciding what mutual funds to add to your TFSA you’ve got some choices:
|Mutual Fund||Risk||MER||10-year performance returns|
|Money Market||Low||up to 0.8%||3-4%|
|Income||Low-medium||up to 1.5%||2-6%|
|Balanced||Medium||up to 2.5%||3-7%|
|Growth (Equity)||High||up to 2.5%||up to 20%|
Most funds only require you to start with $100-$500 (depending on the financial institution) although some premium funds have a $50,000 or $100,000 starting balance.
Money market funds
These type of funds invest in short-term securities such as treasury bills and bank notes. As these are low risk your initial investment is protected (but not guaranteed like GICs are). Choose these if you want low risk over the short to long term.
These type of funds invest in a combination of fixed-income securities, bonds, and stocks with a higher potential for growth. Choose these if you want low-to-medium risk over the medium term.
Balanced funds come in a variety of flavors and most financial institutions will have their own specific combinations. The MERs are generally higher than with income funds, but the potential return is greater. Choose these if you are comfortable with medium risk over the long term.
Also known as Equity Funds, these primarily invest in publicly-traded stocks. You can choose these based on region (Canada vs US vs global), company size (small to large cap), and industry type (energy, tech, precious metals, etc). Choose these if you are ready for high risk investing with the potential for high returns.
Load vs no-load mutual funds
When deciding to purchase mutual funds you have to decide whether you want to buy load or no-load mutual funds. Load funds charge a commission fee and are generally sold by individual mutual fund companies, brokers, and insurance companies. No-load mutual funds don’t charge a commission fee and are generally sold by the banks. Most people go with no-load funds if they are setting up a TFSA through their bank; self-directed TFSA-holders generally go with the load funds.
Mutual funds and the credit unions
Nowadays many people are choosing to invest their TFSAs and mutual funds with their local credit union. There can be significant advantages such as lower MERs and low (or no) monthly fees. Make sure your mutual funds are insured by checking to see if the credit union is registered with the Canada Deposit Insurance Corporation or the provincial equivalent. If so, your first $100,000 is insured.
Mutual funds for the self-directing investor
As with the major banks, the starting balance for mutual funds ranges from $100 to $500. You’ll probably get a better MER since you won’t be paying any commission fees, but it may not kick in until you reach a certain threshold in your mutual funds (which could be as high as $36,000). Watch out for monthly processing fees outside the MER. Note that these fees have nothing to do with your TFSA contribution limit.