3 Main Different Types of Mutual Funds to Choose From

Go and search around, you may find that there are easily hundreds of mutual funds available in the market. You may even find it hard to remember some of the names. Too many funds can confuse you in the process of choosing suitable ones for yourself.

 

Do not worry, as there are basically only 3 main types of mutual funds for you to choose from, no matter what name it carries. By understanding the different types of mutual funds, you will find it much easier to look for a fund which suit you the most.

 

3 Main Different Types of Mutual Funds to Choose From

 

Equity Funds


Equity funds basically invest in stocks. That is why they are also known as stock funds. Equity funds are the most volatile and the highest risk fund type. Their values may rise and fall significantly in a short period. But according to past records, stocks have performed better than other types of investment in the long run.

 

There are mainly 3 categories of equity funds, differentiated by the market capitalization of the stocks in the their investment portfolio

  • Small-cap stocks, where the capital is less than $500 million

  • Mid-cap stocks, where the capital stands in between $500 million to $5 billion

  • Large-cap stocks, where the capital is exceeding $5 billion

Not all the stock funds are identical. The main purpose of each equity fund can be recognized by the name it carries. For instance:

  • Growth funds are the type of equity fund that aim for capital appreciation and usually do not declare dividend.

  • Income funds, on the other hand, pay regular and steady income in the form of dividends to the investors.

  • Sector funds invests solely in equities of companies in a particular industry or sector of the economy.

  • Index funds are built to track the components of a market index, such as the S&P 500, BSE Sensitive index, Composite Stock Price Index etc

Bond Funds

 

Bond funds are also known as fixed income funds. They invest basically in bonds and other types of debt securities. The main aim of bond funds is to provide steady streams of income to the investors via dividend payments.

 

Many people have misconception that bond funds have no risk. It is not true as they are also exposed to investment risks like prepayment risk, interest rate risk and credit risk. What are these risks mean?

  • Prepayment risk - When the bond owned by the fund is paid off early, the fund manager may have to reinvest the money somewhere else. The manager may not be able to find an investment tool that pay as high a return.

  • Interest rate risk - When the interest rate rises, the market value of bonds will generally go down, thus causing value of the funds to decline.

  • Credit risk - When the issuer of bonds default on their payment, the value of the bond funds which invest in the bonds will decrease.

The risk could be low if the fund mainly invest in government bond. If the fund focus on investing in high-yield corporate bonds, then the risk could be high. However, risks of bond funds are generally much lower than the equity funds.


Money Market Funds

 

Money market funds are a type of mutual fund which are required by law to invest in short term low risk securities. Fundamentally, they invest in certificates of deposit (CD), government securities, commercial paper of companies and other highly liquid and low-risk securities. They carry the lowest risk among the three types of funds. The aim of the funds is to earn interest for the investors while trying to keep their net asset value (NAV) of $1 per share.

 

Money market funds generally carry the past records of lower return in the long run compare to equity and bond funds. Hence, they may not be able to outperform the inflation rate at times, thus making them not a favourite investment tools.

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