Investments for Beginners: Types of Mutual Funds

Becoming familiar with the different mutual fund types will help you select the funds appropriate for your personal financial situations. It is important to note that there is market risk involved when investing in mutual funds, including possible loss of principal.

While there are many types of mutual funds, most typically fall into the following categories, based on their investment objectives:

Equity or stock funds

  1. Aggressive Growth Funds
Aggressive growth funds aim to maximize capital gains (buy low and sell high). These funds may leverage their assets by borrowing funds, and may trade in stock options.
These funds often have low, current yields. Because they don't invest for dividend income, and often have little cash in interest-bearing accounts, short-term yield is not optimized.
If the market is going up, these are the funds that will benefit the most. Conversely, aggressive growth funds are the ones hardest hit in bear markets. The volatility of these funds makes them inappropriate for risk-averse investors.
  1. Growth Funds
Growth funds are similar to aggressive growth funds, but do not usually trade stock options or borrow money with which to trade. Most growth funds surpass the S&P 500 during bull markets, but do a little worse than average during bear markets.

Just as in aggressive growth funds, growth funds are not aimed at the short-term market timer. The aggressive investor may find that they are an ideal complement for aggressive growth funds, as the differing investment strategies used by the two types of funds can produce maximum gains.

The volatility of these funds makes them inappropriate as the sole investment vehicle for risk-averse investors.

Combined or hybrid funds

Growth-Income Funds
Growth-income funds are specialists in blue chip stocks. These funds invest in utilities, Dow industrials, and other seasoned stocks. They work to maximize dividend income while also generating capital gains. These funds are suitable as a substitute for conservative investment in the stock market.

Bond or Fixed Income Funds

  1. Income Funds
Income funds focus on dividend income, while also enjoying the capital gains that usually accompany investment in common and preferred stocks. These funds are particularly favored by conservative investors.

  1. Bond Funds
Bond funds invest in corporate and government bonds. A common misunderstanding among investors is that the return on a bond fund is similar to the returns of the bonds purchased. One might expect that a fund that owns primarily 8 percent-yielding bonds would return 8 percent to investors. In fact, the yield from the fund is based primarily on the trading of bonds, which are extraordinarily sensitive to interest rates. Thus, one could find a bond fund that was earning double-digit returns as the prime rate climbed from 4 percent to 6 percent.

3.      Money Market Funds
The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won't get great returns, but you won't have to worry about losing your principal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD). 

Index Funds 

Index funds are designed to produce the same return that you'd get if you owned all the stocks in a particular index — such as the Standard & Poor's 500-stock Index or the broader Wilshire 5000 Index, which includes all of the stocks traded on U.S. markets.

Index funds are popular in bull markets because the performances of the major stock indexes are typically strong, increasing the value of the fund. They may be less attractive in bear markets when the value of the index may drop.

Specialty Funds

This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don't necessarily belong to the categories we've described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy.

  1. Sector Funds
Sector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank.
  1. Regional funds 
Regional funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession.

  1. Socially-responsible Funds
Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitive performance while still maintaining a healthy conscience.

  1. International Funds
International funds hold primarily foreign securities. There are two elements of risk in this investment: the normal economic risk of holding stocks; as well as the currency risk associated with repatriating money after taking the investment profits. These funds are an vital aspect of many portfolios, but any individual fund may prove too volatile for the average investor as the sole investment.

  1. Asset Allocation Funds
Asset allocation funds don't invest in just stocks. Instead, they focus on stocks, bonds, gold, real estate, and money market funds. This portfolio approach decreases the reliance on any one segment of the marketplace, easing any declines. A plus factor is limited by this strategy as well.

  1. Precious Metal Funds
Precious metal funds invest in gold, silver, and platinum. Gold and silver often move in the opposite direction from the stock market, and thus these funds can provide a hedge against investments in common stocks.

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