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Investors have more mutual funds available to them than there are corporations issuing stocks and bonds. Mutual funds can be categorized by their investment objectives: growth, income, balanced or variations of these. They may also be classified by the market in which it chooses to invest, like stocks or municipal bonds or by industry, such as energy or technology.
In this tutorial, we will break down mutual funds into their objectives and markets. The following subjects will be covered:
Growth funds are a type of stock fund structured to appreciate over time. These funds invest primarily in common stock of corporations that show high potential for growth. Growth funds may realize their objectives by choosing businesses with a particular capitalization (or cap). Small-cap businesses are small companies that grow quickly. Mutual funds that invest in these businesses are unlikely to pay dividends to their customers because small-cap businesses stress growing in value as their top priority. Large-cap businesses are larger, more established companies (many are also blue chip stocks) that may grow less rapidly. They tend to have large amounts of assets and cash on hand to protect themselves against economic downturns. Some examples are IBM and General Electric. The mid-caps are medium-sized companies with good growth potential. Some have the long history of the large caps.
Of the amount charged, a portion
may be paid as compensation to brokers.
Aggressive growth funds are similar to growth funds. The major difference is that aggressive-growth portfolios are more strongly growth-oriented. Aggressive-growth funds often choose common stock of small promising companies. They may also use investing techniques like options writing and frequent trading to maximize their growth possibilities.
The prices of aggressive growth funds can fluctuate greatly. They are popular among those who tolerate volatility well and who want to leave their money in their funds for a long time. Like growth funds, aggressive-growth funds often forego paying dividends so they can invest their earnings back into the companies they hold.
In contrast to growth stocks, there are stocks that focus on paying dividends
to their customers -- the income stocks.
INCOME FUNDS
Income funds are structured to provide regular income dividends to their investors. They focus on paying dividends as their top priority while de-emphasizing the growth in value of their portfolios.
Income funds place a large percentage of their funds into preferred stocks and bonds because these investments yield relatively stable current income. They may also invest in cash and money market securities.
Income funds are popular with investors who want stable income from their mutual funds.
There are also funds that involve paying income and seeking growth...all in one. Read below to learn about Balanced Funds.
BALANCED FUNDS
Balanced funds invest in common stock, preferred stock, bonds and cash equivalents to provide both current income and growth with a minimum of volatility.
The objective of balanced funds is to provide both of these ends together. On the average, their ratio of stocks to other investments is about 60:40. Managers of balanced funds can, however, shift this ratio one way or the other to take advantages of high interest rates or stock market growth. Balanced funds generally have low volatility and are popular with investors seeking current income with growth potential.
MARKET-ORIENTED FUNDS
SPECIALIZED FUNDS
Specialized funds limit their holdings to securities in one industry. They may choose industries such as health care, the automobile industry, biotechnology or pharmaceuticals. To be classified as a specialty fund, a fund must put at least 25 percent of its money into one industry. Specialized funds are also called sector funds. They are considered by many to be aggressive-growth.
When a few companies in an industry perform poorly, others may be affected. Trends in an industry often cut across company lines. That has happened in the past few years with Internet stocks. This disadvantage may bring down much of the value of the fund. On the other hand, certain industries will outperform the market as a whole.
Advisors often suggest that investors interested in specialized funds know the sectors they are choosing.
BOND FUNDS
Bond funds invest primarily in debt securities to provide current income with preservation of principal. They are generally conservative in nature (except for high-yield bonds) and focus on paying dividends and preserving principal. Below are the most commonly bought types of bond funds.
Municipal bond funds invest in municipal debt securities. State and local governments issue these. Their income dividends are free from federal taxes, although capital gains from distributions or sales are taxable. Municipal bonds may be short-term, intermediate-term or long-term.
U.S. government bond funds invest in debt securities of the U.S. government and its agencies to produce current income with preservation of principal. The federal government is thought to be a good risk and can pay interest and repay principal quite effectively. These funds include Treasury bills, Treasury notes, Treasury bonds and mortgage-backed securities.
Corporate bond funds are made of bonds issued by companies in the private sector. They are considered less risky than stock funds because of the "corporate guarantee to pay interest and principal." However, a guarantee is only as good as the financial strength of the guarantor.
Zero-coupon bond funds are pools of zero-coupon bonds. A zero-coupon bond is a bond that is sold to an investor at a discount. It does not pay interest. When it matures, the investor receives the face value of the bond. The difference between the face value and the discounted purchase prices is treated as "interest." While current income is not the objective of a zero coupon bond fund, the fund can and may pay dividends if it has any realized income. When buying shares, the investor pays the current market value of the fund. The investor can always redeem his or her shares for cash.
International bond funds invest in debt securities of governments and corporations of other nations. They are attractive to some investors because higher rates may be paid in other countries. However, changes in currency conversion rates can alter the earnings values of these bonds.
Convertible securities funds invest in debt securities that allow the fund to convert its bonds into stock. These funds have the objective of current income and growth with preservation of principal. Thus, they offer characteristics of stocks and bonds. Additionally, while in down times stocks can fall to very low prices, convertibles can still earn the income of bonds.
MONEY MARKET FUNDS
Money market funds invest in debts with short-term maturities and liquidity. "Short-term," in the case of money market investments, means one day to one year. These funds seek to pay current, stable income. They include certificates of deposit, commercial paper, repurchase agreements and U.S. Treasury bills.
Money market funds are popular with conservative investors. When the market enters a downturn, these investors can place their money into these funds for safety until stocks move upward again.
INDEX FUNDS
An investor wishing to keep his or her mutual fund's pace in line with a measurement of the market like the Standard and Poor's 500 may consider index funds. These funds are made up of the securities that comprise major market indexes. The advantage of index funds is that they are always in line with the market as a whole. Their downside is that they can't outperform the market.
Index funds that use the same market index are not the same, however. Some divide their holdings evenly among the various stocks, and some divide them by dollar amounts so that bigger companies comprise a larger share.
OTHER TYPES OF MUTUAL FUNDS
There are more mutual fund types on the market than can be explained here. We have shown you the most common types. Some other interesting mutual fund types include the following:
Multifunds, which invest in other mutual funds
All-weather funds, which are structured to survive in all phases of the business cycle
Emerging-growth funds, which buy companies that are poised to grow rapidly
Precious metals funds, which choose gold, platinum and other valuable metals
Green funds, which invest in companies believed to be environmentally responsible by the fund managers.
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