Mutual Funds: More types of Mutual
Funds
Index Funds
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The index fund's assets are invested to replicate the performance of a
existing market index such as Standard & Poor's 500 (S&P 500), an
index of 500 large U.S. company stocks. They are mostly managed by a
computer and don't need a research team, as such, have very low annual
expense for investors. Why the index funds? Over a long period of time,
index funds outperform about 78% of any other type of funds. Plus, index
funds can't underperform the market since it mimics the market exactly.
Unless the fund has high fees and poor management. Look for low
expense ratio index funds such as
Vanguard
S&P 500 index fund (800-662-7447, ticker: VFINX) has only .18% annual expense fee
with minimum initial deposit of $3,000.
International/Global and
Regional Funds - An
international fund invests only outside your home country. Global funds
invest anywhere around the world, including your home country. Most of
these funds carry high annual expense fee (well in excess of 1.5 percent
per year). It's tough to classify these funds as either more risky or
more safe. On the one hand they tend to be more volatile and have unique
political risks. But, they can actually reduce risk by increasing
diversification. Even though the world's economies are becoming more
inter-related, it is likely that another economy is outperforming the
economy of your home country.
Regional funds make it easier to focus on a specific area of the world.
This may mean focusing on a region (For example, Asia) or an individual
country (Japan). An advantage of these funds is that they make it easier
to buy stock in foreign countries. Just like for International or global funds,
you have to accept the high risk of loss, which occurs if the region
goes into a bad recession.
Specialty (Sector) Funds
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Specialty funds are also
called sector funds because they tend to invest in a specific sectors of
the economy such as financial, technology, health, transportation,
electronics, etc. These funds are extremely volatile, you may experience
big gains, but you must be willing accept that you may lose big. This
type of mutual fund defeats the purpose of diversification and carry
higher expenses than other type of funds.
Increasing numbers of mutual funds have been coming up with Socially-responsible funds.
These invest only in
companies that meet the criteria of certain guidelines by avoiding
investing in companies whose products or services harm people or the
world at large (industries such as tobacco,
alcoholic beverages, etc.). The idea is to get a
good return on your money while still keeping a healthy conscience.
Hybrid (Balanced)
Funds - Hybrid funds invest in combination of different types of
securities (mostly in stocks and bonds). The objective of these funds is to
provide a balanced mixture of safety, income, and capital appreciation. Thus, a
balanced fund. A typical balanced fund might have a weighting of 65% stocks and
40% bonds. These funds are mostly less risky and volatile than funds investing
in stocks only. That's because bonds hold up better in an economic down turn and
when the economy is good, stock market rises.
A similar type of fund is known as an
asset allocation fund. It's objectives are similar to those of a balanced fund, but
these kinds of funds typically do not have to hold a specified percentage of any
asset class. The portfolio manager is therefore given freedom to switch the
ratio of stocks to bonds according to it's expectations of the market. Hybrid
funds make investing easy and simple with instant diversification.
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What are Exchange Traded Funds (ETFs)?
A security that tracks an index but has the flexibility of trading
like a stock. Just like an index fund, an ETF represents a basket of
stocks that reflect an index. The difference is that an ETF isn't a
mutual fund - it trades just like any other company on a stock
exchange. Unlike a mutual fund, which have their net asset value (NAV)
calculated at the end of each trading day, an ETF's price changes
throughout the day from buying and selling.
The best way to think of an exchange traded fund is as a mutual fund
that trades like a stock. By owning an ETF you get the
diversification of an index fund, as well as the ability to sell
short, buy on margin, and purchase in amounts as little as 1 share.
Another advantage is that the expense ratios for most ETFs are lower
than the average mutual fund. When buying and selling ETFs, you have
to pay the same commission to your broker that you'd pay on any
regular stock order.
The most widely known ETFs are: SPDR (Spiders), which tracks the S&P
500 index, DIA (Diamonds), which tracks Dow Jones Industrial Average
and QQQ (Cubes), which tracks the Nasdaq-100. |
Next-->>
How to
choose Mutual Funds
In time of prosperity our friends know us;
in time of
adversity we know our friends.
-- Churton J. Collins
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