Types of Mutual FundsBefore talking about types of mutual funds, what is the basic concept about? Most people are probably familiar with mutual funds at least on some level, probably from their retirement plans. When it comes to investing, the word "fund" can basically mean taking a pool of cash and investing it in a wide variety of securities. This concept applies to mutual funds. A mutual fund is a collection of cash from multiple investors pooled together for the purpose of investing in stocks, bonds and money market instruments. A mutual fund is run by a money manager, who decides which stocks, bonds, and other assets to invest in. A mutual fund is designed to achieve maximized growth with as little risk as possible. If you’re interested in investing without really actively participating in the day to day management of the investments, a mutual fund could be what you’re looking for. One advantage of a mutual fund is that a professional money manager runs the fund, and while there are expenses, they are relatively low cost. That is compared to hiring your own money manager and picking and choosing individual stocks. There are many options available with mutual funds, let’s explore a few of them and get past some of the jargon. Types of mutual funds range from aggressive growth funds that invest in emerging market stocks, to extremely conservative cash funds.
Active vs. Passively Managed FundsWhen looking for an investment, the first distinction among types of mutual funds you can consider is how the fund is managed. The distinctions are pretty simple: • An actively managed fund is actively run by a professional money manager who is constantly buying and selling securities in an effort to maximize the return of the fund.• A passively managed fund buys a set of securities and just holds them. For example, the Vanguard 500 fund invests in the S & P 500. As you’re aware, simply tracking the stock market or large sectors of the market can be a very profitable enterprise-often more profitable than individual stocks. In many cases it will even beat actively managed funds consisting of lots of securities. The Vanguard 500 is one of the top performing funds. At the time of writing, the Vanguard 500 Index fund has $87.3 billion in assets. The disadvantage of actively managed funds is that they are more expensive. As we said, a money manager is actively managing the fund-hence its name-analyzing, buying, and selling stock. To have a professional money manager doing this for you, well you have to pay him (or her). Since the cost is spread out over everyone investing in the fund, which can be hundreds, thousands or tens of thousands of people, the cost really isn’t that high. Annual fees can be around 1.6% of assets. So if you invest $5,000, your fee would be around $82. If you invested $20,000, the fee would be around $326. As far as management among types of mutual funds, passive funds are cheaper, and my perspective is that if you can invest $20,000, are you going to worry about a $326 fee? So the distinction between active and passive funds can rest in investment philosophy: • Do you want to have a money manager actively working the stocks? If so get an actively managed fund.• Would you rather invest in the S & P 500 or a market segment like healthcare, and just track it for years? If so you’ll want a passively managed fund.• A third option: buy a mix of mutual funds. Diversify your diversity. Get an actively managed fund and one that tracks the S & P 500, for example. Now let's talk a little about distinctions among the kinds of stocks invested in by different types of mutual funds.
Growth vs. ValueOf course people find ways to make things more complicated, and with mutual funds this is as true as ever with a plethora of options. Do you want to grow rapidly by pursuing securities with lots of earnings, or are you looking for a safe bargain? If you’re in the former camp, you’ll want a growth managed fund. For the latter, you’ll go with a value manager. If you want to go in between, look for a GARP-growth at a reasonable price. Examples, the Vanguard Mid-cap Growth Fund (https://personal.vanguard.com/us/funds/snapshot?FundId=0301&FundIntExt=INT ): • Seeks to provide long-term capital appreciation.• Invests primarily in the stocks of midsize domestic companies with strong earnings and revenue growth prospects.• Uses fundamental research methods—including extensive discussions with company management and the assessment of earnings, profitability, market share, and product lines—to select a small portfolio of stocks.That one requires a minimum investment of $10,000 (ouch!). An alternative might be the small-cap value fund, from Vanguard: • Seeks to track the performance of the MSCI® US Small Cap Value Index, which measures the investment return of small-capitalization value stocks.• Provides a convenient way to match the performance of a diversified group of small value companies.• Follows a passively managed, full-replication approach. https://personal.vanguard.com/us/funds/snapshot?FundId=0860&FundIntExt=INT
Large-cap, mid-cap or small-capAs you know the market consists of large-cap, mid-cap and small-caps. Luckily there is a mutual fund for you if this is your fund. Not only that, but you can look for large growth or mid-value stocks, or small-value and large-growth stocks (we already saw that in the last section). If this type of investing suits your fancy, pick a size and then pick growth or value. Growth and value aren't the only types of mutual funds when it comes to stocks. If you want a mix between growth and value, picked a blended fund. A blend is a mixture of growth and value stocks. Like growth and value funds, blended funds can be purchased for large-cap, mid-cap, and small-cap. Other types of mutual funds track specific benchmarks like the S & P 500, these are very good to invest in.
Sector FundsSome types of mutual funds invest in stocks from particular sectors like technology companies. Investors can find funds that track just about any specific sectors. These include: • Energy• Utilities• Healthcare• Technology• Financial services• Real Estate• Telecommunications Sector funds are something the small independent investor should definitely consider adding to their portfolio. You do need to use care when picking among these types of mutual funds. You can examine the top holdings of funds you are interested in to find the best one that suits your investment goals.
Bond FundsSome types of mutual funds invest in bonds. Bond trading isn’t that easy for the small investor-so one area where a mutual fund might prove superior is investing in bonds. As we’ll see, there are some caveats however. First, what are you getting into, with a bond fund? A major difference between these types of mutual funds and going it alone, is that when you invest in bonds by yourself, you will buy individual bonds that each have: • A set maturity date (the date when the repayment of the principal comes due)• A set interest rate With a bond fund, you’re having a money manager invest in multiple bonds simultaneously. In fact a bond fund may invest in hundreds of different bonds. They each have their own maturity date and they each have their own interest rates. A bond fund doesn’t even guarantee return of principal to the investor. If its an actively managed fund-the money manager will be buying and selling bonds. Since different bonds have different interest rates, that means the yield for your bond fund will fluctuate as the money manager buys and sells different bonds. Not only does the yield fluctuate as the money manager buys and sells, the value of the bond fluctuates with the overall interest rate. A rise in interest rates will cause a decline in bond prices. Remember that interest rates and bond prices are inversely related. So a drop in interest rates means a rise in bond prices and vice versa. According to Investing Demystified, a 1% rise in interest rates could mean a 6% loss for a bond fund portfolio. On the other hand, a decline of interest rates could mean a steep rise in the value of a bond portfolio. So like anything else, it’s a matter of getting into bond types of mutual funds at the right time, and getting out at the right time. That being said, a bond fund seeks the same goals that investing in bonds does in the first place-it’s a more conservative investment than stocks. Rather than trading some risk for high returns, bond funds seek to preserve the principal you invest while paying out regular interest income. At this point, you might be asking why invest in a bond fund? It seems to have some disadvantages. But there are some advantages as well. • For a small investor, buying bonds as an individual can be difficult. The cost of entry can be prohibitive, and buying bonds online isn’t that easy. Buying into a fund overcomes this problem. Many bond funds have small minimums to get started, or you can invest in bonds as part of a balanced mutual fund. • Bond types of mutual funds make diversified investment in bonds easy.• Shares of bond funds are bought and sold more easily than buying individual bonds, so it’s a more liquid investment.• You might be able to spread your risk, that is have some high yield bonds in your portfolio. In an earlier chapter we already talked about bonds, so you are already aware of some of the nuances of bond investing. The options for bond fund investing follow along theses lines. The first option is the length to maturity: • Ultra-short funds: Invests in bonds that mature in 1 or 2 years• Short: Invests in bonds that have a maturity in the 2 – 5 year range• Intermediate: Invests in bonds with a 5-7 year range• Long term: Invests in bonds with a 10 + year maturity As we discussed in the chapter on buying individual bonds, long term bonds carry the highest risk of default, since the loan is spread over a longer time period. Bond funds are also broken down along the same lines as bonds you’d buy individually, in the sense that you can look at: • Corporate bonds• Government bonds• Mutual bonds• State bonds You can even invest in mortgage backed securities-not that anyone would want to do that these days. Bond funds should be part of any diversified portfolio, but you’ll want to get into bonds at the right time. Generally speaking, you’ll want to get into bonds when interest rates are high (so the value of a bond fund portfolio is lower). At the time of writing, interest rates are as low as they can go, so late 2009 is probably not a great time to invest in bonds. Many people shift between bonds and stocks as markets and economic conditions fluctuate, and in fact many Balanced Funds (funds with a certain % invested in stocks, and a certain % invested in bonds) change their weights as market conditions change. Be careful making such moves-remember if the stock market crashes-that’s the best time to get into it-when everyone else is getting out. That way you can buy low at bargain prices to sell high later. The allocation of a balanced fund depends on how much “risk” you want with your investments. • A higher % of stocks in the fund means more risk, but potential for higher growth.• A higher % of bonds in the fund is more “conservative”. More likely to preserve principal, but also strong possibility of smaller returns. There are a wide variety of types of mutual funds with different asset allocations to choose from, if you join Vanguard or Fidelity (for example) you can find funds with varying degrees of risk. A general mix for a balanced fund is 60% stocks, 40% bonds. A conservative allocation will be weighted more towards bonds, so might only have 40-50% in stocks. There are many more types of mutual funds available than we have space to cover here. Click on the link below to get more info.
Have a contribution to share about this topic?Do you have a great story about this? Share it! |