Different Types of Mutual Funds Explained

July 18, 2022, 11:51 AM

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Mutual funds are a popular investment choice for many reasons. They are managed by professionals and typically include diverse investments across different industries.

Mutual funds are also good starter investments since they are generally affordable. In addition, the funds are liquid for investors who want to redeem shares for the net asset value.

4 Main Types of Mutual Funds

There are four major types of mutual funds: money market funds, equity funds or stock funds, bond funds and target-date funds. Read on to learn about each type.

Money Market Funds

Money market funds are made up of investments that are issued by federal, state and local governments, as well as some U.S. corporations. While they are considered low-risk investments, the returns may not be as substantial as with other types of funds or investments.

The investments included in a money market fund have a short-term outlook, and they pay dividends that are close to the typical short-term interest rates. Shares of most money market funds have a net asset value of around $1. However, the NAV must float based on the market value of the securities in the institution’s portfolio, which means it could fluctuate slightly.

Equity Funds

Equity funds, also known as stock funds, are made up of stocks from U.S. corporations. There are different types of equity funds, each with its own level of risk:

  • Growth funds: Stocks in the fund have the potential for above-average financial gains.

  • Income funds: Stocks in the fund pay dividends.

  • Index funds: Stocks in the fund track a specific index, such as the Nasdaq or S&P 500.

  • Sector funds: Stocks in the fund are focused on one specific industry or sector.

Most equity funds are also categorized based on company size, such as small-cap funds and large-cap funds.

Bond Funds

Bond funds invest in government and corporate debt. They may be able to provide a more stable return — compared to volatile investments like growth stocks — since they pay a fixed amount back to the investor.

Many of the same rules for bond investing apply to bond funds. The primary difference is that investors are investing in multiple bonds through a fund rather than one bond individually.

The risk level associated with bond funds can vary greatly, depending on the types of bonds being held in the fund, so it’s important to understand how the fund is diversified before investing.

Target-Date Funds

Target-date funds feature a variety of investments, including stocks, bonds and more. These funds are designed to shift strategies, with a target date set for people who are looking to retire around a specific time.

Target-date funds will typically invest in riskier investments and then shift to a lower-risk portfolio as they get closer to the target date. Since the funds typically have a target date set in five-year intervals, some people have begun using these funds while saving up for future goals, such as college tuition or retirement.

Other Types of Mutual Funds

Aside from the four main types listed above, the following are some less popular types of mutual funds:

  • Asset allocation funds: These invest in a variety of securities based on a fixed percentage set for different asset classes. For example, a fund may have a 60% allocation for stocks and 40% for bonds.

  • Hedge funds: These invest in a variety of securities, typically using riskier investment strategies. They are typically recommended for experienced investors.

  • Commodity funds: These invest in commodities, which are raw materials or basic goods used in commerce, such as grains or fuel.

  • Real estate investment funds: These invest in real estate investment trusts, which are companies that pool together capital to invest in real estate.

Other types of mutual funds exist as well, so it’s crucial for investors to research all the options to find one that’s a good fit.

Final Take

Mutual funds are made up of many different types of investments. They are managed by professionals and include diversified securities, which may help minimize risk. Mutual funds are a good investment tool for beginner investors since they are affordable and accessible.

Investors should choose a mutual fund based on their financial goals and desired level of risk. Researching a mutual fund’s past performance and its prospectus is essential to making an informed investment decision.

This article originally appeared on GOBankingRates.com: Different Types of Mutual Funds Explained

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