Guest Author - Reshma Vyas
Mutual funds are a popular investment vehicle for many investors because they offer instant diversification, professional management, and relatively low transaction costs.
However, the task of choosing even a single mutual fund can seem at first, overwhelming, due to the sheer volume of mutual funds. Many beginning investors and even long-time investors often invest in mutual funds without bothering to familiarize themselves with the investment objective of the fund in question. Understanding the differences among mutual funds with regard to investment objective is vital to securing a well-diversified fund portfolio and can also help avoid or at the very least, reduce investment duplication.
Generally speaking, there are 3 classes of mutual funds such as bond, stock and money market. However, each fund class can be further divided into smaller and even more specific sub-classes. For example, within the stock class, there is the growth category which can also contain small-cap growth, large-cap growth, or even micro-cap growth funds. These in turn can be further subdivided into other categories that focus on a particular geographical area or sector such as technology small cap-growth. Index funds (there are a plethora of them) invest in a selection of securities that mirror a specific market index such as the S&P 500, the Russell 3000 or Wilshire 5000 among others. Mutual funds that invest in both stocks and bonds are often referred to “balanced” funds.
The following is a broad list of major mutual fund categories, excluding index funds and it is worth nothing that there can be tremendous overlap. Mutual fund investment companies also develop and market new funds to take advantage of the prevailing public and/or market interest in a particular sector or investing style (such as growth, value or blend) at a given time:
Special Situation Funds (these funds utilize an investment approach that seeks to profit from companies that are undergoing a financial transition such as reorganization.). They may also invest in companies that offer potential profit as a result of mergers, acquisitions, buybacks or divesting and/or purchase securities that are “undervalued” or currently out of favor.
Value funds can also fall into this category.
GROWTH AND INCOME
Balanced funds can also be included in this broad category.
International (i.e., specific country funds, diversified international, emerging markets, developed markets only, large-cap, mid-cap, small-cap, limited to a specific geographical region or a sector such as international real estate)
Various Growth and Income
Corporate Bonds (various investment grades)
Municipal (single state, diversified)
High Yield or Junk Bonds
International Bonds (can be limited to developed markets or emerging markets.)
Generally speaking, balanced funds invest in fixed-income securities as well as equities. They may invest in any combination of common stocks, preferred stocks and bonds. A balanced mutual fund may consist of 60% equities and 40% fixed income or bond holdings (the exact percentage will vary). Asset allocation funds can also fall under this category (i.e., Aggressive Allocation, Conservative Allocation, Moderate Allocation).
Target Retirement Portfolio or "Life-Cycle" Funds utilize an “age-based” approach to investing. Money is invested to meet a specific retirement “target" date. There are many categories such as growth, growth and income, aggressive allocation, moderate allocation, etc.
Financial Services (can be limited to the brokerage sector, savings and thrift institutions, money banks, etc.)
Real Estate (domestic or international)
Science and Technology
Utilities (can be limited to a particular sub-specialty such as water or electric companies.)