There are many types of mutual funds in the market to choose from. Each has its own holding and objective and potential for capital gains and risk of loss. But broadly categorising, the main kinds of mutual funds are equity funds, bond funds, and the money market funds.
A Mutual fund that tries to provide a safety of capital will have the priority of protecting the initial investment from loss. The funds that target the growth invest in equities to increase the return on the investment and give investors a capital gain. Bond funds offer the investors a stable and regular payment.
So let us understand each kind of mutual fund in detail and see what they have to offer to the investors.
ACTIVELY MANAGED & INDEX FUNDS
The actively managed mutual funds have a portfolio manager which buys & sells the investments on behalf of the investor in order to outperform the market. Usually, the expense fees are higher for these types of funds.
The alternative to actively managed funds is a passive fund or an index fund. The index funds invest the money in equities or fixed income securities chosen to mimic a certain index such as S & P 500.
If an investor was looking to keep up with the market growth rate, these are the type of funds they would be looking at.
MONEY MARKET FUNDS
The Money Market Funds are mutual funds invest in U.S. treasury bills and commercial paper. They try to maintain a table net asset value of $1 per share while returning interest in the form of dividends to investors. They are considered as low risk and low return investments as they invest in low risk investments while paying out all gains in dividends (removing the compounding of capital gains).
The investors who are looking for short-term returns with great stability should consider these funds as an option. Mainly the ones who are close to retirement or those who are already retired go with this option. The money market funds offer high liquidity to the investor; that means they can be used as emergency cash fund while still obtaining higher returns than savings accounts.
The money market funds are often used as short term loans to corporations and banks; are extremely secure, and often times guaranteed by the government. This makes them suitable replacement of simply holding cash.
The bond funds can be seen as fixed income, or income funds; the terms are synonymous with each other. This kind of funds invests the money in a combo of treasury bills, debentures, mortgages and bonds. The main objective of bond funds is to provide a regular income payment through the interest the fund earns with a possibility of capital gains.
Each one of these bond funds has a specific emphasis: corporate bonds, government bonds, municipal bonds, agency bonds, and much more. Majority of these funds have certain maturity objectives, which relate to the average maturity of the bonds in the fund’s portfolio. Bond funds are either taxable or tax free, depending on the funds owned by that bond. They carry interest rate risk, especially longer-term bonds.
There are several categories of equity funds because there are many different types of equities. Equity funds invest the money in stocks and these funds’ goal is to grow faster than money market or fixed income funds.
They can be further classified as small-cap, mid-cap, or large-cap, and foreign equity.
The small-cap funds invest in corporates with sizes between $300 million and $2 billion, but the size can vary for each fund.
A mid-cap fund invests the money in companies having size range between $2 billion and $10 billion in market cap, but again this definition can change depending on the fund.
The large cap funds invest the money in the stocks of the biggest companies in the world, having market caps in excess of $10 billion. These comprise of all the big names such as Apple, Exxon and Google. The large-cap funds generally possess a lower growth rate than small cap funds and mid cap funds, but they are typically safer and some provide dividends giving an extra boost to returns.
The foreign equity funds, or you can say global or international funds, invest the money in a specific region outside of an investor’s home country. These funds sometimes offer very high returns, but it is hard to classify them as either riskier or safer than domestic investments.
The balanced funds invest in different equities and bond securities. The objective is to balance the safety and return of bond securities and equities respectively. Majority of the funds divide the money between two different kinds of investments, depending on whether their goal is more aggressive or more conservative.
The aggressive ones have more equities and conservative funds hold more bonds. As the name suggests, balanced funds are a mixture and thus have more risk than bond funds but lower risk than pure equity funds.
The speciality funds emphasize on specialised objective such as the sector funds, real estate, quantitative strategies, currencies, and other special types like funds of funds.
The funds of funds are unique as they invest in other funds and achieve a higher diversification than with a single investment fund. But the expense fees for these funds is comparatively higher than normal funds as there are two sets of fees being paid.
The huge variety of mutual funds available to today’s investors provides them with more investment choices than ever before. While some may look really good, it can also be intimidating. If you are aware of different types of mutual funds, you can easily choose which funds appeal to you and your own investment goals and then narrow down your investment selection from there.