Types of Mutual Funds

Mutual funds may be classified into types, according to organization, fees charged, methods of trading funds, and investment objectives.

There are two general types of mutual funds. An investor in an open-end fund may request at any time that the fund buy back, or redeem, that investor's shares. The price of shares in an open-end fund is based on the market value of the fund's portfolio of investments. Investors in open-end funds may be charged additional fees known as loads. Front-end loads are charged when the investor purchases shares in a mutual fund; back-end loads are subtracted from the redemption price. Open-end funds are sold by securities dealers and brokers and financial planners, or they are sold directly to the investor by the fund's sales staff.

Closed-end funds are traded on stock exchanges or the over-the-counter market. Unlike open-end funds, closed-end funds usually have a fixed number of shares, which are purchased and redeemed at their market price plus a commission.

Mutual funds are broadly classified according to three types of investment objectives:

- growth of capital
- stability of capital
- current income

Most funds are geared toward one or two of these objectives. For example, money-market funds invest in instruments like U. S. Treasury bills, which are relatively safe and generally stable. Therefore many investors view money-market funds as a good alternative to a bank account. Other funds seek stability of capital by investing in blue-chip stocks and high-quality bonds. Some funds are potentially more lucrative, but far riskier. Growth funds are somewhat aggressive, investing in speculative securities that show promise over time for slow but steady long-term return. Income funds also tend to be speculative, often investing in high-risk, high-yield securities with the goal of greater short-term return. Within the three broad categories of mutual funds are numerous subcategories. Funds that seek both growth and income are known as balanced funds. Sector funds invest in certain types of businesses, such as the computer industry. Some funds strive to fulfill a political agenda, such as investing in environmentally responsible companies or companies that actively promote women and minorities. Precious metals funds, municipal bond funds, and international stock funds are other examples of mutual fund categories. Other funds are far less specialized and allow the fund manager free reign to compile and alter the fund's portfolio.

Most mutual funds fall into one of three main categories — money market funds, bond funds (also called «fixed income» funds), and stock funds (also called «equity» funds). Each type has different features and different risks and rewards. Generally, the higher the potential return, the higher the risk of loss.

Bond Funds

Bond funds carry more risk than money market funds are often used to produce income (useful in retirement) or to help stabilize a portfolio (diversification). The primary types of bond funds are:

- Municipal Bond Funds — uses tax-exempt bonds issued by state and local governments (these funds are non-taxable).
- Corporate Bond Funds — uses the debt obligations of U. S. corporations.
- Mortgage-Backed Securities Funds — uses securities representing residential mortgages.
- U. S. Government Bond Funds — uses U. S. treasury or government securities.

Another way bond funds are often classified is by maturity, or the date the borrower (whether it be the bank, the government, a corporation or an individual) must pay back the money borrowed. Using this classification bonds are often called short-term bonds, intermediate-term bonds, or long-term bonds.
Bond funds generally have higher risks than money market funds, largely because they typically pursue strategies aimed at producing higher yields. Unlike money market funds, the SEC's rules do not restrict bond funds to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards. Some of the risks associated with bond funds include:

Credit Risk — the possibility that companies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Credit risk is less of a factor for bond funds that invest in insured bonds or U. S. Treasury bonds. By contrast, those that invest in the bonds of companies with poor credit ratings generally will be subject to higher risk.

Interest Rate Risk — the risk that the market value of the bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or Treasury bonds. Funds that invest in longer-term bonds tend to have higher interest rate risk.

Prepayment Risk — the chance that a bond will be paid off early. For example, if interest rates fall, a bond issuer may decide to pay off (or «retire») its debt and issue new bonds that pay a lower rate. When this happens, the fund may not be able to reinvest the proceeds in an investment with as high a return or yield.

Money-market Funds

These funds are a great place to park your money. Whether you're storing money for emergencies, saving for the short-term, or looking for a place to store cash from the sale of an investment, money market funds are a safe place to invest. These funds invest in short-term debt instruments and typically produce interest rates that double what a bank can offer in a checking account or savings account and rival the returns of a CD (Certificate of Deposit). The beauty of money market funds is that you can often write checks out of your account and they provide a high amount of liquidity (ability to cash out quickly) not found in CD's. These funds are not FDIC insured, but in the history of money market funds no money market fund has ever folded, yet many banks have failed and many investors with over $100,000 lost out.

Stock Funds

Although a stock fund's value can rise and fall quickly (and dramatically) over the short term, historically stocks have performed better over the long term than other types of investments including corporate bonds, government bonds, and treasury securities. Overall «market risk» poses the greatest potential danger for investors in stocks funds. Stock prices can fluctuate for a broad range of reasons, such as the overall strength of the economy or demand for particular products or services. Money market funds and bond funds typically provide returns just a percentage or two above inflation, but stock funds should do much better over long periods of time.

Types of Stock Mutual Fund

Here are many types of stock funds (also referred to as equity funds). As you can imagine, stock funds are more popular than bond funds and money market funds, especially for younger investors. Here's a break down of the most common types of stock funds:

Strategy Types:

- Growth Funds — These funds invest in stocks believed to be the fastest growing companies in the market. Growth funds rarely provide dividend income and are considered risky investments.
- Value Funds — These funds invest in large and mid-sized companies that appear to be overlooked or out of favor. These undervalued stocks tend to pay dividends.
- Blend Funds — These funds are a «blend» of both growth and value stocks.

By size:

- Large-Cap Funds — These funds invest in companies whose market value (# shares outstanding X current market price) is large. By large, I mean greater than $9 billion. These «blue-chip» funds tend to be well-established corporations and tend to pay dividends.
- Mid-Cap Funds — These funds invest in mid-sized companies whose market value is more in the range of $1 billion to $9 billion.
- Small-Cap Funds — These funds invest in emerging companies whose market value, is less than $1 billion. These companies tend to use profits to grow rather than pay dividends.

Index Funds

These funds try to mimic a chosen index. Examples of indices include the S&P 500, NASDAQ, and the Russell 2000. An index is simply a group of stocks chosen to represent a particular segment of the market. Usually this is accomplished by purchasing small amounts of each stock in a market.
Index funds are a hands-off approach to investing. The manager is not trying to find the hot stocks or great deals. Instead, the manager is simply trying to match an chosen index. The results are funds that are very cost efficient, meaning the operating costs are very low, and often beat most actively managed funds.

International Funds

- Global Funds — These funds invest inboth U. S. and International stocks.
- Foreign Funds — These funds invest primarily outside the U. S.
- Country Specific Funds — These funds focus on one country or region of the world.
- Emerging Markets Funds — These funds focus on small developing country and are considered very risky.

Global and foreign funds may be fixed income, growth or balanced funds that invest in foreign securities. These funds can offer investors international diversification and exposure to foreign companies, but are subject to risks associated with investing in foreign countries and foreign currencies.

Sector Funds

Sector funds choose to invest in a particular industry or segment of the market. Examples of sectors include automotive, technology, baking, air transportation, biotechnology, health care and utilities.

Basis of Mutual Funds | Fees and Expenses | The Risks of Investing | Selecting Fund | Duties of Mutual Funds | List of Indian Mutual Funds