Mutual Fund Types Explained
So you have decided to buy a mutual fund but you are not sure what type of mutual fund to invest in. Well, let's take a look at the different types of mutual funds you have to choose from. The three main categories of mutual funds are: Equity, Bond, and Mixed. Equity funds invest in stocks, bond fund invest in bonds, and mixed funds invest in both stocks and bonds.
While bond mutual funds can fill a specific need, the majority of funds are equity funds. Equity funds can be further classified into many different categories. I will explain the most common categories. A very popular type of mutual fund is an index fund. An index fund tries to closely match the holdings of a particular index such as the S&P 500, the Dow Jones, or the NASDAQ 100. The value of an index fund will move up and down with the index. For example, if you own a S&P 500 index fund and the S&P 500 goes up, your index mutual fund will increase in value. Conversely, if the index goes down, the value of your mutual fund shares go down.
Another popular type of mutual fund is a sector fund. This is similar to an index fund except it has a narrower focus. Specific types of sector mutual funds are utilities, natural resources, technology, biotech, pharmaceuticals, and energy. Basically, a sector mutual fund is a group of stocks from a specific industry. If your sector does well your mutual fund will do well. If your sector performs poorly, your mutual fund will suffer.
Equity mutual funds can also be broken into investment objective. The two most common classifications are growth funds and value funds. Growth mutual funds look to invest in companies that have shown consistent growth and are likely to continue to produce steady growth. Value mutual funds try to find bargain stocks or companies that are currently out of favor with investors but are very sound fundamentally and undervalued.
Yet another classification of mutual funds is based on stock size such as small cap, mid-cap, or large cap. While the exact classifications can differ, a small cap stock generally has less than 1 billion in market cap (the stock price x the number of shares outstanding) and a large cap stock has over 5 billion in market cap. A mid-cap stock is somewhere in between. Most large cap companies are well known companies such as GE, Exxon, or Microsoft. Small cap companies offer higher returns but they are also more risky.
Finally, mutual funds can be domestic, foreign, or international. An international fund is generally a combination of U.S. companies and foreign companies. Foreign mutual funds can be further classified into regions (Latin America, Asia) or country. While this isn't a complete list of mutual fund types it should help explain many of the types and choices available to the mutual fund investor.