6 Different Types of Mutual Funds Explained
Mutual funds are a popular investment choice for many reasons. They are managed by professionals, so that makes them a good choice for those who lack either the desire or the time to run their own investment portfolio. They also typically include diverse investments across different industries, making them a “one stop shop.” With a single purchase, you can instantly own hundreds of different securities.
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Mutual funds are also good starter investments since they are generally affordable. Many mutual funds these days have no commission to buy or sell, meaning in addition to paying no commission to buy, the funds are liquid for investors who want to redeem shares for the net asset value.
But before you take the plunge into mutual funds, you’ll have to understand what you’re getting into, since there are literally tens of thousands of mutual funds to choose from. You can buy a mutual fund for nearly any type of investment, from small stocks in emerging countries to health care stocks to long-term bonds. You’ll have to do the research to find funds that suit your investing needs.
Equity funds
Bond funds
Money market funds
Index funds
Sector funds
Balanced funds
6 Main Types of Mutual Funds
There are six major types of mutual funds: stock funds, bond funds, money market funds, index funds, sector funds and balanced funds. Read on to learn about each type.
1. Equity Funds
Equity funds, also known as stock funds, are made up of stocks from U.S. corporations. There are different types of equity funds, each with its own level of risk. Some of the many types of equity funds include the following:
Domestic: Stocks in companies based in the United States
International: Stocks in companies based outside of the United States
Market cap: Stocks in various companies based on size, such as mega, large, mid or small cap
Equity funds as a category are actively managed by professional managers. Index funds may hold equities but they are passively managed, as explained in the section below. Here are three top actively managed equity funds:
Fidelity Advisor Equity Growth Z (FZAFX): This fund, rated 5 stars by Morningstar, invests in both domestic and foreign equities and has a long and consistent track record.
Janus Henderson Enterprise T (JAENX): This outperforming, 5-star fund invests more than 50% of its assets in mid-cap funds, providing investors with exposure away from the dominant large-cap group.
DFA US Small Cap I: This small-cap fund invests in a broad variety of smaller and less well-known names that are still profitable in an effort to generate capital appreciation.
2. Bond Funds
Bond funds invest in income-generating securities issued by governments and/or corporations. They typically pay a monthly dividend and are better suited for investors looking for a regular check instead of capital appreciation. They’re generally less volatile than equity funds but can still suffer capital losses during periods of rising interest rates.
Individual investors may be attracted to bond funds because professional managers with experience in the space typically have more knowledge about which bonds to buy. Here are three of the best:
Fidelity Total Bond Fund (FTBFX): This bond fund is free to invest in almost any type of bond, from government and corporate issues to high-yield and emerging market asset classes.
Baird Core Plus Bond Fund (BCOSX): This fund invests primarily in intermediate-term bonds in an attempt to outperform the Bloomberg U.S. Universal Bond Index.
Dodge & Cox Income I (DODIX): This fund seeks high income by investing at least 80% of its assets in investment-grade bonds.
3. Money Market Funds
Money market funds are made up of investments that are issued by federal, state and local governments, as well as some U.S. corporations. While they are considered low-risk investments, the returns may not be as substantial as with other types of funds or investments.
The investments included in a money market fund have a short-term outlook, and they pay dividends that are close to the typical short-term interest rates. Shares of most money market funds have a net asset value of around $1. However, the NAV must float based on the market value of the securities in the institution’s portfolio, which means it could fluctuate slightly.
While there are not as many differences between individual money market funds as there with other types of funds, the best ones have low expenses and high yields, such as:
Vanguard Treasury US Money Market Investor (VUSXX)
North Capital Treasury Money Market Fund (NCGXX)
Vanguard Federal Money Market Fund (VMFXX)
4. Index Funds
An index fund is a passively managed fund that tracks a specific index, such as the Nasdaq or S&P 500.
SPDR S&P 500 ETF (SPY): The original S&P 500 index fund, the SPY tracks the 500 largest companies in America and is also the most actively traded ETF in the world.
Schwab Total Stock Market Index Fund (SWTSX): A traditional mutual fund, not an ETF, the Schwab Total Stock Market Index Fund attempts to track the total return of the entire U.S. stock market in a single fund.
Invesco QQQ Trust (QQQ): This popular ETF tracks the Nasdaq-100 index, which consists of the 100 largest non-financial companies listed on the Nasdaq.
5. Sector Funds
Sector funds focus their investments on a single industry or sector. For example, a fund might be dedicated to technology stocks or health care stocks only, with no diversification into other sectors. While generally not advisable as a core holding, it can be a great way to invest in a particular industry that you feel is primed for success without having to worry about selecting individual stocks. Some of the most popular sector funds are as follows:
Fidelity Select Semiconductors (FSELX): This outstanding fund has ranked in the top 1% of funds in its category over the past 3- and 5-year periods.
Lazard Global Listed Infrastructure Open (GLFOX): Another fund that crushes its category, GLFOX invests in infrastructure stocks in industries such as utilities, pipelines, toll roads, airports, railroads, ports and more.
Fidelity Select Construction & Housing (FSHOX): As the name suggests, this top-tier fund invests in construction and housing-related stocks, such as Home Depot, Lowe’s and individual home builders.
6. Balanced Funds
As the name suggests, balanced funds offer a “balance” of stocks and bonds. While the traditional balance is about 60% equities and 40% bonds, individual funds are free to set their own parameters. You’ll want to do your research to see exactly what the weighting in any specific balanced fund is, and what types of bonds and equities they purchase as well. The concept behind a balanced fund is to offer the capital upside of stocks while balancing out their risk with bonds.
T. Rowe Price Balanced (RBAIX): This fund normally allocates 65% of its portfolio to stocks and 35% to bonds, aiming to provide growth and income, along with preservation of capital.
American Funds Moderate Growth & Income (BLPEX): This fund seeks income and long-term growth of capital; it has a bit more flexibility than other funds allocating at least 45% to stocks and at least 25% to bonds.
Vanguard Wellington (VWELX): Vanguard Wellington sticks to an allocation of about two-thirds stocks and one-third bonds in an effort to provide growth and income.
Other Types of Mutual Funds
Aside from the four main types listed above, the following are some less popular types of mutual funds:
Asset allocation funds: These invest in a variety of securities based on a fixed percentage set for different asset classes. For example, a fund may have a 60% allocation for stocks and 40% for bonds.
Hedge funds: These invest in a variety of securities, typically using riskier investment strategies. They are typically recommended for experienced investors.
Commodity funds: These invest in commodities, which are raw materials or basic goods used in commerce, such as grains or fuel.
Real estate investment funds: These invest in real estate investment trusts, which are companies that pool together capital to invest in real estate.
Even other types of mutual funds exist as well, so it’s crucial for investors to research all the options to find one that’s a good fit.
What Are the Three General Types of Mutual Funds?
There are many different ways to divide the types of mutual funds, but they can be thought of in terms of three broad categories: stock funds, bond funds and money market funds.
What Is the Safest Type of Mutual Fund?
The safest type of mutual fund depends on how you define risk. U.S. Treasury funds have essentially zero credit risk, but they still carry the interest rate and inflation risks that all bonds do. Stock funds carry the risk of capital loss, but over time they tend to outperform inflation, removing that risk.
Which Type of Mutual Fund Is High Risk?
Stock funds generally carry the highest risk of capital loss, and this is the risk that most investors are sensitive to. Within the stock world, small cap and emerging market stocks are among those with the highest risk, but even large-cap technology funds can be volatile.
Final Take
Mutual funds are made up of many different types of investments. They are managed by professionals and include diversified securities, which may help minimize risk. Mutual funds are a good investment tool for beginner investors since they are affordable and accessible.
Investors should choose a mutual fund based on their financial goals and desired level of risk. Researching a mutual fund’s past performance and its prospectus is essential to making an informed investment decision.
Taylor DeJesus contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: 6 Different Types of Mutual Funds Explained
