Planning for the future is one of the most important steps any person can take, and mutual funds are one of the best ways to ensure you and your family have a decent nest egg to fall back on.
As of right now, there are almost 8,000 different types of mutual fund out there, most of which are variations of specific themes. Here are just some of the broader categories you’ll run into.
Types of Mutual Funds
1. Alternative Funds
A sub-type of fixed income fund, alternative funds are less liquid than their kin. They hold various assets, such as bank loans, global real estate, and junk bonds.
The amount of risk involved varies, although this type of mutual fund benefits from some protections under the Investment Company Act of 1940. FINRA provides an excellent breakdown of alternative funds.
2. Balanced Funds
Balanced funds mix both stocks and bonds into one package, earning them the nickname “hybrid funds”. This blend creates a wider choice of options than sticking to either fixed income or equity funds.
As there is a mix of assets, these funds tend to provide less risk than equity funds and higher returns than fixed income funds. A formula is generally used to calculate the allocation of money, although the final amount of stock vs bond investments ultimately comes down to investor preference. The expense ratio for balanced funds was estimated at 0.80 percent in 2013.
3. Domestic Equity Funds
Domestic equity funds are a form of equity fund where the stock portfolio contains exclusively stocks from companies in that nation. For example, a U.S. equity fund portfolio will contain only companies based in the U.S.
4. Equity Funds
The poster boy of mutual funds, equity funds are a great way to invest in the stock market without having to deal with individual company stocks. This means far less research and less initial risk in regards to stocks while providing a faster return at greater risk compared to other types of mutual fund.
Over time, the fund will reflect the profits and losses of those stocks it contains, but the diversity included greatly reduces any risks inherent in stock market investment. In 2013, it was estimated that U.S. equity funds carried an expense ratio of 0.74 percent.
Nerdwallet gives a nice breakdown of how equity funds work and how they compare to regular stock trade.
5. Fixed Income Funds
Have you ever wished you could make money off of the government instead of the other way around? Fixed income funds (more commonly referred to as bond funds) do just that!
When you invest money into a fixed income fund, you are actually loaning money to help pay off different types of debt owed by large companies, government agencies, or even home mortgages.
These funds have a lower return than many other types of fund, but have lower fees. In 2013, the expense ratio was estimated at around 0.61 percent. The amount of risk varies depending on the category of fixed income fund you choose, but profits are generally interest-based and thus tend to have a regular influx of money over time.
6. Index Equity Funds
This type of equity fund mimics an actual stock market index. This usually translates to incredibly low mutual fund expense ratios and greater simplicity. You may choose either a passively managed fund where no fund manager is employed, or an active fund which relies on a fund manager to fill modify the portfolio to get the most of market trends.Growth Funds
A form of equity fund that favors companies with an above-average growth potential, these portfolios commonly include stocks from the technology and pharmaceutical sectors. They can pose a higher risk due to the experimental and fickle nature of these sectors, but the potential rate of return tends to be just as high.
A variation, dividend growth funds, invest in businesses that have a track record for increasing dividends per share at a much faster rate than the general stock market and are great for a buy-and-hold strategy.
7. Market Capitalization Equity Funds
More of a strategy than a specific form of equity fund, these portfolios take advantage of company size to choose which stocks will be included.The levels include micro-cap (companies valued in the low millions) to small-cap, mid-cap, large-cap, and mega-cap (which includes only the biggest companies such as Microsoft of Walmart).
8. Money Market Funds
This subcategory of fixed income funds provide short-term returns. The downside is that they have a lower potential return. Money market funds may include such funds as certificates of deposit, government bonds and treasury bills.
9. Municipal Bonds
A great tax-free form of fixed income fund, municipal bonds take advantage of municipal debt. Purchasing one of these bonds provides a loan in exchange for a set number of interest payments during the predetermined loan period.
While a taxable form of municipal bond is available, the tax-free version is more popular. While very low risk, the credit history of a bond issuer may provide warning of potential missed payments ahead of time.
Investopedia’s explanation of municipal funds is well worth a look before choosing to invest in this time of mutual fund.
10. Private Equity Funds
Many privately owned companies aren’t available on the stock market. Often, these are LLCs (Limited Liability Companies) that issue bonds instead of creating stocks.
While such companies aren’t without risk, they can be a more stable investment than the working the stock market. In most cases, these companies are in the business of buying, improving, and selling smaller businesses at a profit using the money earned by issued bonds.
11. Sector Equity Funds
This form of equity fund restricts the stocks in its portfolio to a specific industry or sector. This gives better control over investments, allowing a savvy investor to support high return industries or aim for a more stable investment sector that produces lower returns for less risk.
12. Taxable Bond Funds
Fixed income funds tend to be either taxable or non-taxable in nature. Taxable bond funds are a sub-category in which the returns from your fixed income fund are taxed. This creates a reduction in the amount of your returns.
This tax may be due either every year or (in the case of zero coupon bonds and treasury bonds) due when the bond has matured. In the former case, the amount earned for that year is taxed, whereas the latter is only taxed for the difference between the invested and final amounts.
Taxable bond funds are usually issued on a national or corporate level. For more information about taxable bond funds, please check out this excellent article by Investopedia.
13. Value Funds
A relatively low-risk version of equity fund, value funds focus on investing in slow-growth companies. These stocks tend to be undervalued and may be purchased at a price lower than their actual worth.
While the returns may not be as great, potential losses also tend to be proportionally smaller. Note that value funds usually don’t pay dividends.
14. Worldwide Equity Funds
An excellent way to protect against market crashes, worldwide equity funds contain a range of stocks from all over the world in no particular ratio. Usually the portfolio manager will have their own methods for dictating how diverse these portfolios are.
An alternative is the global equity fund, which has a set ratio of 80 percent or more of the stocks you’ll be investing in coming from other countries. A third variation is the international equity fund, which excludes domestic stocks in favor of a 100 percent foreign market portfolio.