The mutual fund market is booming at the moment. This is because a lot more folks realize the benefits that come with underlying investments like mutual funds. One of these benefits is that you get professional management. Actively managed funds and investments are less likely to lose money. Thus, even though the inherent threat of running into losses still exists, a mutual funds investor can rest assured of some gains.
Furthermore, mutual funds give investors the room to access a diversified portfolio. They also have a high liquidity ratio. Mutual funds buy investments and pay dividends from the profits they make.
Of course, there are some drawbacks also. Firstly, you will be unable to control the fund and what the pooled resources can be invested into. Similarly, the volatility of the market means that you can never truly be free of losses. However, this is a risk every investor eventually comes to terms with.
Mutual fund companies are varied, thus, so are the various types of mutual funds that exist. This review looks at the different types of mutual funds, enumerating the benefits and drawbacks of each. You will find the knowledge you’ll glean here invaluable as you begin your mutual fund investment journey.
What are Mutual Funds?
Mutual funds refer to an investment strategy where mutual fund investors pool their money into a centrally-controlled fund. Mutual funds invest the gathered resources into asset classes like growth stocks, money market instruments, and even bonds.
A mutual fund makes money in three crucial ways. The first is through dividends. Each investor is entitled to a portion of the earnings of the company in the form of dividends. Similarly, the funds can sell off its securities at a profit. It then shares this profit with its investors. Finally, the fund also makes a profit when the value of the shares increases.
It is great financial advice to invest in mutual funds. One of the main reasons for this is that the investment risk you experience in this arrangement is usually lower than in other investment pathways, such as stocks. This is because mutual fund investors own just a percentage of the entire pool. Thus, their risks are reduced to their investments.
Additionally, mutual funds typically have a diversified portfolio. Mutual fund managers select a mix of growth funds, bonds, and others. This makes it almost impossible for all of the securities to do terribly at the same time. Thus, mutual funds provide a viable pathway if you earn a fixed income and need an easy investment route to take.
Types of Mutual Funds
The fund manager typically invests the funds bearing in mind the investors’ investment objectives. Thus, mutual funds are of various types. Below, we will discuss the specific types and the subgroups under each. Coupled with a clear plan, your chosen investment professional will be the most profitable for you.
Mutual Funds Based on Asset Class
Below are the different types of mutual funds based on the asset class.
Money Market Funds
Money market funds refer to mutual funds invested in the money market. The money market is known as the capital market or cash market and is the equivalent of the traditional stock market. The government runs the money market in association with financial entities such as banks. Money market funds invest into assets such as dates securities, certificates of deposit, and T-bills. Dividends are shared periodically with investors.
Equity mutual funds focus on stocks. Thus, they are often regarded as stock funds. In an equity mutual fund, various investors pool their money together. The fund manager then allocates the money to different shares in various companies.
There is no fixed return an investor can make at the end of a period. Capital gains depend on how well the stocks fare in the market. Equity funds can generate high returns. In such a case, since there is no fixed interest rate as you have with bond funds. An equity funds investor also earns huge sums.
However, on the other hand, there is also the possibility of huge losses. As a result, financial advisors typically advise only experienced traders to explore equity funds. People in this category can better predict and weather any losses they encounter along the way.
Bond funds are also known as debt funds. Unlike other mutual funds, bond funds invest in fixed-income securities like bonds and treasury bills. Bonds are further categorized into various types such as investment-grade corporate bonds, government bonds, etc. A bond is like a corporate debt owed by one entity to another. Hence, when a government issues bonds, investors receive a certificate of indebtedness, showing that the government, in theory, owes them some money.
This is a fixed-income kind of investment because dividends are stated and periodic. Thus, bond funds are some of the best types of investment options open to individuals, especially those looking to be passive investors. You will not have to do much but can rest assured of some money coming into your account at the end of a stated period.
These are also known as balanced funds. Here, you have a mix of shares and bonds. Thus, you have both an equity fund and a debt fund in this type of mutual fund. The fund manager can either decide on a fixed model of the distribution of the assets in the fund or leave it variable.
Mutual Funds Based on Investment Objectives
Different investors have particular aims they strive to achieve. Below are the types of mutual funds based on this categorization.
Most mutual funds are categorized based on how long they last. Liquid funds have the shortest lifespans. Investors who use this type of mutual fund expect returns within a short period. Hence, liquid funds are typically not ideal for long-term investment plans such as retirement investments.
Aggressive Growth Funds
Generally, growth funds invest in stocks and shares. These securities are said to belong to the growth sectors.
Aggressive funds, specifically, are designed to make huge gains over short periods. Thus, aggressive growth funds invest in stock and shares, although the exact style of the investment is up to the fund manager.
This type of mutual fund is susceptible to market volatility. Hence, the value of the mutual fund could go up and come down unexpectedly. Therefore, only those who are experienced in the sector or have a huge risk appetite ought to consider investing here.
Income funds distribute the pooled resources into bonds, certificates of deposits, and securities. This is exactly the way bond funds operate also. Due to the fixed returns they grant investors, income funds are typically more used than bond funds. Records also show that income funds consistently yield the highest returns for investors. Mutual funds carry risks, just like any other investment option you may want to consider. However, if you are risk-averse and want to invest for only a short period, consider using income funds.
Target Date Funds
A target-date fund is an investment vehicle usually used to save for retirement. In this arrangement, the investment adviser or fund manager picks an investment close to your estimated timeline. The fund manager then reassesses the fund periodically to ensure that the aims are still on target.
Here, the mutual fund seeks to place the portfolio on autopilot with minimal supervision from the fund manager. Similarly, just like fixed-income funds, target-date funds have a high-risk tolerance. As a result, the fund usually gets less radical and employs flexible strategies with time. However, at the initial stages, there is a high-risk tolerance threshold that fund managers can exploit.
Specialty Mutual Funds
Specialty funds, also known as alternative funds or alternative investments, are the types of mutual funds that do not fall into any of the categories above. They serve special functions to investors. Below are a few.
In sector funds, the investment strategy is to invest in specific sectors at a time. Here, managers buy a few stocks at really high prices. The justification is usually the possibility of huge gains from such investments. Sector funds are notoriously volatile and hence can give large profits within a short while. However, on the other hand, risks are also very high.
Index funds are focused on the performance of any particular market index. There are several of those available such as the S& P’s 500 Index and so on. Index funds will depend on the value of the index that it tracks. Thus, if the index goes up, the value of the mutual funds goes up and vice versa.
An investment advisor will find it easy to invest in index funds. This is because they only have to focus on the particular index they are tracking, nothing more.
Global funds and international funds are often used interchangeably. However, these two types of mutual funds differ in certain key respects. International funds invest resources into markets of other countries. Hence, the investment objective is more outward-focused, and the investment risk is high. It will be terrible financial advice to have anyone invest in international funds if they are not well-grounded with various countries’ international political and financial policies. You will be merely setting yourself up for failure.
Global funds invest internationally, but also locally. This is the difference between the two. A global mutual funds investor can hedge their risk by also investing in terrains they are familiar with. Thus, if you earn a fixed income and cannot afford to take huge leaps and risks, you should consider global funds instead of international funds.
Socially Responsible Funds
This sort of mutual fund shares some similarities with sector funds. Here, the investor only considers investing in companies that reflect its values and principles. For instance, investors in this category will typically invest in companies that champion environmental conservation, gender empowerment, and other ethical considerations.
Asset Allocation Funds
An asset allocation fund works like a hybrid fund. Hence, the investment company has a mix of both equity and debts. However, asset allocation funds require a high level of expertise. Therefore, mostly seasoned fund managers dabble into this kind of fund management to forestall huge losses.
An exchange-traded fund employs the same mechanism as index funds. Thus, securities are bought and sold on exchanges instead of indices. The fund manager monitors the advances in the stock exchange market after the initial investment. This is not a good investment fund to explore if you want to be a passive investor. You need to be tuned to what happens in the stock exchange.
It is great investment advice to consider including mutual funds in your investment consideration. Here, we have enumerated the benefits of mutual funds and the different types available. Before settling for any, consult an experienced manager, be sure that the Federal Deposit Insurance Corporation covers the one you select.