To learn about the different types of mutual funds, watch this 1-minute video or scroll down to read the full article
By: Robert F. Abbott, freelance writer and author
Ah, you’ve made a decision. You’re going to invest, and you’ve decided on a mutual fund or funds. But, your decision making isn’t finished. Now, you have to decide what type or types of mutual funds, and that’s no easy decision.
Many of us start the next stage by reviewing the types of mutual funds available, and making some broad initial choices. Let’s do that here, starting with the three broadest categories:
Stock or Equity Funds
These funds own stocks in corporations. Generally, they generate the biggest returns for investors, but they also expose us to the greatest risk of losses (although rarely as much as owning a few stocks outside a mutual fund). The fortunes of most companies correspond to the business cycles; some lead the cycle, some trail, and most go along with it. Read more about stock funds .
Also known as fixed-income funds and bond funds, these are the second major type of mutual fund. As the alternate name suggests, these are made up of bonds or financial instruments that behave like bonds. These funds exhibit less volatility than equity funds, but also tend to return less to investors.
Within the realm of bond funds, you will find variations that reflect the risk involved. For example, corporate bonds offer higher returns, but also greater risk, than government bonds. Read more about bond funds .
Money Market Funds
The third main type of mutual fund offers even lower returns than income funds, but expose us to virtually no risk. For most investors, money market funds serve short-term parking needs, rather than long-term investing. For example, you might use a money market fund if you were waiting a few weeks or months for the price of stock to reach a certain level. In most cases, inflation will eat up any gains made by money market funds, so few of us find them suitable for the long term.
So, those are the three major types or categories: equity, income, and money market funds. Beyond that, fund companies and investors themselves, mix and match to create a rainbow of fund possibilities. Let’s take a quick look at a few of the more common of them. Read more about money market funds .
These combine the three types above, so investors don’t have to do it for themselves. Depending on the fund and its objectives, balanced fund managers will put together some combination of stocks, bonds, and cash. Different funds have different blends, depending on their objectives. Those that want to add a little extra yield will have a heavier weighting in stocks and a lower weighting in bonds, and funds that emphasize safety will tilt the other way. Similarly, managers of some funds may vary the balance according to the economic cycles, with more stocks and fewer bonds when the economy is growing or strong, and the opposite when a slow-down is expected or has already occurred. Read more about balanced funds .
Seek to replicate the returns of a public index; the Dow Jones Industrial Average is probably the best known of such indexes. Since index funds are automatically made up of all the stocks in the targeted index, no active management is needed, making the fund inexpensive to operate. In addition to stock index funds, you can also find bond index funds if you want to own a risk-reduced, inexpensive fund. Read more about index funds .
Global, or International, Funds
Give us exposure to stocks, bonds, or both in other countries, or selected countries. A well diversified American investor, for example, will own some European or Asian funds, as well as American funds. Since 2009, funds based on companies in the BRIC (Brazil, Russia, India, China) nations have been popular with investors looking for greater growth than they can get in the developed countries. Read more about international funds .
Combine features of mutual funds and life insurance. Normally sold by life insurers, these funds may guarantee investors won’t lose their principal, but at the same time may be costly. And, since cost can reduce the return we receive, that could negate the purpose of investing in the first place. Still, segregated funds have their place, especially for the highly risk-averse.
These are relatively new, and designed to attract the interest – and dollars – of socially-conscious investors. For example, this type of mutual fund does not invest in industries or companies that sell liquor, tobacco products, guns, or nuclear power.
Still scratching your head, wondering where to start, even though you now know about the major types of mutual funds? That’s quite normal, because we still have more essential discoveries ahead, as well as closer examination of some of the types of funds listed above.
Knowing Your Own Mind
More important than your fund choices, though, is your personal awareness. Investment counselors usually try to identify your tolerance for risk before making any recommendations, and you should too. To start the process, I recommend this article: Determining Risk and the Risk Pyramid.
Beyond this, please go to a search engine and type in something like this, “investing risk assessment”, investment risk survey”, or “investment risk calculator” with or without the quotation marks. While you may be in a hurry to start investing, please take your time at this stage, and get to know your risk tolerance and that of your spouse, if that’s applicable. It’s time well invested.
Next, read about Stock, or as they’re also called, Equity Funds
Mutual Fund Fact 2: 96.2 million Americans owned mutual funds in 2013 (2014 Investment Company Fact Book)