- Mutual funds fall into four main types: equity funds, bond funds, hybrid funds, and money market funds.
- Equity funds tend to be riskier, while bond funds are generally more risk averse.
- Knowing about the different types can help investors find the one that works best for their financial goals.
- Visit Insider’s Investment Reference Library for more stories.
Mutual funds are among the most popular means of investing. They pool investor money to create a large portfolio of stocks and bonds, or even commodities like precious metals or commodities. Mutual funds do the research and investing for you and therefore are one of the easiest ways to diversify your assets.
Investors looking for mutual funds may be faced with an overwhelming number of choices. The biggest difference between the major types of mutual funds is their investment objectives, management approaches and variable target stocks. And different types often have very different risk factors and investment results. Broadly speaking, there are four main types of mutual funds: equity funds, bond funds, hybrid funds, and money market (or short-term debt) funds. We will detail them below.
1. Equity funds
Equity funds invest in shares of companies all over the world. These funds are among the most popular.
Equity funds focus on more dynamic investment growth than other types of mutual funds, especially over the long term. Since equity funds seek high returns, they are considered to be of higher risk. However, in the long run, equity funds can generate a much higher return than other mutual funds. Although equity investments can be volatile, equity funds offer more portfolio diversity than most other types of mutual funds and individual equity investments.
When it comes to equity funds, they are generally divided into different categories based on their composition and investment objectives. These include:
Funds according to the size of the company
Equity funds based on the market value of the companies in which they invest are divided into three main groups:
- Large cape – (over $ 10 billion)
- Average capitalization – (between 2 and 10 billion dollars)
- Small cap – (between $ 300 million and $ 2 billion)
“Remember that there are over 10,000 equity mutual funds, while there are only 2,800 stocks that trade on the New York Stock Exchange,” said Clark Kendall, president and CEO of Kendall Capital. âEquity mutual funds do a great job slicing and carving up stock markets, but you would like your market to be served to you. “
To break up stock markets into investable pieces, funds can also focus on investments in individual economic sectors and break up larger index funds into smaller investable pieces.
The main sectors favored by equity investors are:
Funds based on an investment strategy
Another way to categorize funds is the investment strategy they use, including two of the most popular: growth and value.
Growth funds investing in securities that are considered to have a high potential to outperform the market and in turn produce high returns.
Value Fund Instead, invest in companies that are considered undervalued on the stock market and therefore have a high potential for high return on investment.
Funds that track an index
Index funds invest in the securities of an underlying index with the aim of matching their market performance. Some of the most popular are the S&P 500 and the Dow Jones Industrial Average. Index funds are much less actively managed than most mutual funds. As such, they often have lower fees while providing higher returns than more conservative options such as money market or fixed income funds.
âThere is no selection of securities in the management of a
“Says Sam Dogen, author and founder of Financial Samurai.” The fund manager simply buys all the stocks or bonds in the index he is tracking and rebalances accordingly when positions are added or removed from the index. “
Funds based on geographic location
Some equity funds may also invest only in securities from specific geographic regions, countries and emerging markets.
Socially and environmentally responsible funds
A more recent trend in mutual funds has been “impact investing”. They target companies or projects committed to specific social or environmental causes.
These funds are aimed at investors who are increasingly looking to direct their money to companies that have a positive social or environmental impact in the world. While many of them perform well, the return on impact investments may be lower than more traditional investments.
2. Bond funds
Bond funds, also known as fixed income funds, are more conservative than equity funds and primarily seek to generate income for investors through the collection of interest which is then distributed to investors in the funds. While bond funds are more conservative than equity funds, some can be aggressive and seek higher returns, and some may cautiously seek consistent income from less volatile, lower yielding securities. Fixed income funds can vary widely in terms of
, risks and priorities.
Bond funds are then divided into three main investment categories:
- Corporate bonds: issued by companies that mature over a period of time and pay interest if you hold the bond to maturity
- Government bonds: issued by the U.S. government, including Treasury securities, with interest fully taxable at the federal level and non-taxable at the state level
- Municipal bonds: issued by local governments and other authorities to fund projects such as toll roads, stadiums and hospitals; interest is exempt from federal tax and, in many cases, state and local tax as well
3. Hybrid funds
Hybrid funds invest in two or more asset classes while other mutual funds tend to invest in only one asset class. Hybrid funds often combine stocks and bonds, but can even include commodities like commodities or precious metals. The goal of a hybrid fund is to reduce risk by further diversifying investors’ portfolios, even more than other types of mutual funds. In addition, hybrid funds can offer an investor a combination of income generation,
, and the increase in the net asset value (NAV).
4. Money market funds
Money market funds invest primarily in cash, short-term debt securities and government securities. These funds generally carry the least risk. Money market funds attempt to maintain their net asset value and pay investors the interest earned on the securities they hold.
Money market funds are often used by investors who need their investments to be liquid or who have a short time before they need to access their funds for something else, such as personal purchases. Income generated by certain money market funds may be tax exempt. The conservative nature and Securities and Exchange Commission regulations of these funds make them attractive to the risk averse investor, but they often do not offer high rewards.
The financial report
When choosing a mutual fund, an investor should know what they are looking to get out of the investment. Before investing, determine if you are looking for dividend payments or other forms of income, capital gains, or increased value of the underlying assets, and what your risk aversion is.
Knowing this, investors can better compare themselves to a mutual fund by reading the prospectus which presents the investments, strategy and other key details of the fund. Mutual funds are a great way to increase portfolio diversity, but like all investments, there are some elements of risk to consider before investing.