Be sure to read the 7 Questions to Ask When Buying a Mutual Fund
Actively Managed and Index Funds
The alternative is investing in a passive fund or an index fund. Index funds invest in equities or fixed income securities chosen to mimic a specific index such as the S&P 500. Some index funds will track a larger or smaller number of companies in the index. If an investor was looking to match the market rate of growth, these are typically the funds they would be looking at.
Money Market Funds
Investors who are looking for current or short-term returns with great stability should consider these funds as an option. These investors include those close to retirement or those who are already retired. Money market funds are highly liquid investments which can also be used as an emergency cash fund while still obtaining higher returns than savings accounts.
Money market investments are used as short term loans to companies and banks, are extremely secure, and oftentimes guaranteed by the government. This makes them ideal as a replacement for simply holding cash.
Each of these bond mutual funds has a particular emphasis or objective: corporate bonds, government bonds, municipal bonds, agency bonds, and so on. Most of these funds have specific maturity objectives, which relate to the average maturity of the bonds in the fund’s portfolio. Bond mutual funds can either be taxable or tax-free, depending on the types of bonds the fund owns. Bond funds do carry interest rate risk, especially longer-term bonds.
Small-cap funds invest primarily in stocks in companies with sizes between $300 million and $2 billion, but the size can vary for each fund. Mutual funds have restrictions that limit them from buying large portions of any one issuer’s outstanding shares, which limits the risk while giving an investor exposure to this segment of the market.
A mid-cap fund invests in companies between $2 billion to $10 billion in market cap, but again this definition can change depending on the fund. These are established businesses that are still considered developing and thus have a higher growth rate than large cap funds.
Large cap funds invest in stocks in the largest companies in the world, with market caps in excess of $10 billion. These can include Apple, Exxon, and Google. They have a lower growth rate than small cap funds and mid cap funds, but they are typically safer and some provide dividends giving an extra boost to returns.
Foreign equity funds, or global/international funds, invest in a specific region outside of an investor’s home country. These funds sometimes have very high returns, but it is hard to classify them as either riskier or safer than domestic investments. There are a number of additional risks that have to be considered, including unique country and political risks. As part of a balanced portfolio, they can add additional returns and are worth considering.
Sector, commodity, and currency funds are as their name suggests. Sector funds focus on one particular segment of the economy and invest in securities issued by companies concentrated in that segment. Commodity-focused stock funds don’t invest directly in commodities, but they do invest in companies that are involved in commodity-intensive industries, such as energy exploration or mining. As a result, their performance can loosely track the performance of certain commodities. While these funds can be a great hedge against inflation, they can also be much more volatile than most stock funds.
Quantitative strategies are funds focusing on investments that use financial models to determine what to invest in. They tend to try to exploit inefficiencies in the marketplace or try to predict abnormal market events. As with any model, however, it is only as good as the person who programmed it, and comes with higher risk but higher returns.
Real estate funds may invest directly in a property or indirectly through real estate investment trusts (REITs). REITs invest in income-producing properties such as office towers and shopping centers, so in that sense they are similar to bond funds, but they offer a higher return with higher risk.
Socially responsible investing funds are funds that seek to consider both financial return and social good. These funds encourage practices that promote protection of the environment, human rights, and diversity, which is most often known as ESG: environment, social justice, and corporate governance. According to the 2012 Trends Report, there were 333 socially responsible mutual funds, up from 167 in 2001, and it’s an area that is continuing to grow.
Funds of funds are especially unique in that they invest in other funds and achieve a higher diversification than with a single investment fund. However, expense fees for these are a lot higher than normal mutual funds because there are two sets of fees being paid.