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For the new investors out there it can be a bit tough to scrutinize through the numerous kinds of mutual funds. Generally, there are 4 broad types of mutual funds: Equity Funds (those that invest in stocks), Fixed Income Funds (those that invest in bonds), Money Market Funds (those that invest in short-term debt), and Hybrid/Balanced Funds (those that invest in both stocks and bonds.)
Mutual funds are typically designed to spread the risk while aiming at obtaining wider market gains. There are some types of funds that generally carry a higher potential risk than others, but also higher potential returns. Here is a further detailed thread at the most common types of mutual funds in the market.
These types of mutual funds purchase stocks of a collection of companies that are traded publicly. Equity mutual funds have higher growth potential but are also potentially more volatile in value.
It is advised by many financial advisors that the younger you are, the more equity funds you should be holding in your portfolio. The reason behind this is that you have a wider time horizon to absorb the ups and downs of the market.
Equity mutual funds can be categorized in multiple ways depending on the goals of the fund:
Some funds focus on companies based on the sizes, such as “small-cap” companies or “large-cap” companies. This refers to the value or market capitalization of the companies.
Such mutual funds focus on a specific sector or industry, such as oil and gas, technology, or healthcare. For instance, investors interested in gains from tech companies can put their funds in the technology fund.
Owning funds in different sectors can help in the diversification of your portfolio. In the scenario of one industry falling, the losses can be offset by the gains from the other sectors.
The growth funds, seek to invest funds in stocks that the fund managers believe will have better than the average returns. Value funds look to invest in companies whose stock is undervalued in the market.
The geographic location can also be a factor that helps in determining how mutual funds are built. International funds, as the name suggests, invest in companies outside the residing country, while global funds invest in companies doing business both within the residing country and in abroad. Emerging market funds aim to invest in countries that have small but growing companies.
The bond mutual funds are the most common type of fixed-income mutual funds. In this type of fund, the investors are repaid a fixed amount on the initial investment made by them. These are some of the most popular kinds of mutual funds.
Instead of buying stocks, bond funds invest in corporate and government debt. they are considered to be a safer investment than stocks. However, bond mutual funds have a lesser potential for growth as compared to equity mutual funds.
If you are someone who is saving towards their retirement fund, it is good to hold bond funds in your portfolio. This is because they will earn you more interest on your funds rather than them sitting in your bank account.
Money market mutual funds are a kind of fixed-income mutual funds that invest in short-term, high-quality government, corporations or bank debt. These are considered to be one of the safest kinds of investments.
Balanced mutual funds are also known as asset allocation funds. Such kind of investments is a combination of fixed-income and equity funds with a fixed ratio of investments, for instance, 60% in stocks and 40% in bonds.
The popularly known kind of these funds is target-date funds. These funds reallocate the ratio of investments automatically from equities to bonds, the closer you start to get to retirement.
An index fund is a type of mutual fund investment in which the holdings track or match a specific market index, for instance, the S&P 500. In recent years, index mutual funds have gained popularity because of the passive investing strategy involved. This strategy typically earns higher returns than an actively managed approach.
Index funds, just like equity funds can vary by sector, location, and company size.
This all-encompassing category of funds includes hedge funds, commodities, futures, and real estate.
Fund managers may have different investment strategies or may use different styles of investment to meet the objective of an investor. Choosing funds with different styles of investment allows one to diversify beyond just the type of investment. It can be another approach to reducing risk exposure. Here are the four common approaches to investing:
The Bottom Line
With the wide array of mutual funds available in the market, it becomes a difficult task to pick one option for your investment needs. the simplest advice one can follow is – always understand your needs thoroughly! Once you have done that it is good to move onto figuring out your goal, and your risk appetite.