Mutual Funds: Different Types of
Mutual Funds
At last count, there are more
mutual funds than stocks. Therefore, there are more than enough mutual
funds for you meet your financial goals. It's important to understand that
each mutual fund has different risks and rewards. In general, the higher
the potential return, the higher the risk of loss (Risk and reward goes
hand in hand). Although some funds are less risky than others, all funds
have some level of risk--it's never possible to diversify away all risk.
All mutual funds are not created equal and the name of the mutual fund
aren't always completely accurate. For example a stock fund may not invest
totally in stocks. 10 to 30 percent of it may be invest in bonds and it may
invest in international companies as well. (You can learn more about
Risk and reward in our
investment concepts section.)
Each fund has a predetermined investment objective that tailors the
fund's assets, regions of investments, and investment strategies. There are three
basic type of mutual funds:
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Money Market funds (low risk, low return)
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Fixed-income or bond funds (medium risk, medium return)
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Equity or stock funds (high risk, high return)
Money Market Funds
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The money market consists of short-term debt instruments, such as
Treasury Bills (T-bills).
This is a safest type of mutual funds. You won't get great returns,
but you won't have to worry about losing your invest dollars. You
can earn twice the amount you would earn in a savings account and a little less than the average
certificate of deposit (CD). If you're in a high tax bracket, you can
invest in tax-free money market funds. Most money market funds come with free
check-writing privileges, just like checking accounts. (Learn more about money
market accounts in out money markets section)
Fixed-income or
Bond Funds - Bonds are IOUs. When you buy bonds, you are lending your money to a
corporation or a government agency. A bond fund consist of large amounts of
bonds. Bond funds are also called fixed-income funds because their purpose is to provide
current income on a steady basis. Bond funds typically invest in bonds
of similar maturity (the number of years before you are are paid back the money
you lend). There are three type of bond funds:
- Short-term fund - invests in bonds maturing in 2 to 3 years.
- Intermediate-term fund - invests in bonds maturing in 7 to 10 years.
- Long-tern fund - invests in bonds maturing in 20 years or so.
The main objective of
these funds is to provide a steady income to investors. As such, the
typical investors for these funds consists of conservative investors and
retirees.
Bond funds are likely to pay higher returns than certificates of deposit
and money market investments, but bond funds aren't without risk.
Nearly all bond funds are subject to interest rate risk, which means
that if rates go up the value of the fund goes down and vice versa.
There is one other type of fund worth mentioning, a fund
specializing in high-yield junk bonds is much more risky than a fund
that invests in government securities. Junk bonds have low credit
ratings and these are issued by companies with high risk of default. For
that high risk, you are paid 3 to 4 percentage points in higher interest
than government bonds. (Go to our Bonds Section
to learn more on bonds)
Stock or Equity Funds - Funds that invest in stock are called
stock funds. There are two basic type of stock funds, growth and value.
Growth funds invest in growth stocks, which are companies that are
experiencing strong growth in revenues and profits. These usually
have a high price to earnings (P/E) ratios and/or price-to-book ratios.
Growth stocks either don't pay dividend or very little. On the other
side, Value funds investment managers invest in high quality companies
that are out of favor with the market. These companies are opposite of
growth stocks in that, they have low P/E ratios, price-to-book ratios
and high dividend yields.
Stock
funds can also invest in three types of companies that are defined by
the size of their companies (small, medium, and large). For example,
small-company stocks usually have a market value (capitalization) of
less than $1 billion. Market capitalization is calculated by multiplying
the number of existing shares, or shares the company has issued, by the
current price per share. For example, a company with 100 million shares
of stock with a current market value of $30 a share would have a market
capitalization of $3 billion.
These
categories are combined in different ways to describe how a mutual fund
invests your money. One fund may focus on small-company growth stocks;
another may only invest in large-company value stocks. The main investment objective
with stocks funds are
long-term capital growth with some income. (If you want to learn more
about stocks, go to our Stocks Section)
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What is the Difference between open-end
mutual fund and a closed-end mutual fund?
Like an open-end fund, a closed-end fund takes money from many investors
and turns it over to a professional manager. But in an open-end fund,
shares are continually issued as people invest new cash and
continually redeemed as investors withdraw money. A closed-end fund
raises capital only once, by issuing a fixed number of shares and no
more.
The shares are traded on an exchange, as stocks are, and their
prices fluctuate throughout the trading day, based on supply and
demand as well as on the changing values of their underlying
holdings. Oftentimes this causes the market price of a closed-end
fund to trade either above or below its Net Asset Value (NAV). When
this situation occurs and the fund is trading above this price, it is
said to be trading at a premium and alternatively when the fund is
trading below this price, it is said to be trading at a discount. Most single country
funds are closed-end funds. |
Next-->>
Other Types of Mutual Funds
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