Overview of the various types of Mutual Funds
A mutual fund is an investment fund comprised of money from individual investors or companies.
This fund is managed by an investment professional who uses the money to invest in stocks he or she finds appropriate, depending on the type of mutual fund they are overseeing.
Mutual funds are a great platform for novice investors, as it gives them a chance to build a diverse portfolio with a small monetary contribution and little risk.
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There is some volatility with mutual funds, but generally there will be a return on investment.
Mutual funds pay out in several ways, but most often through dividends. Investors may keep their dividends or reinvest back into the mutual fund.
In order to choose which type of mutual fund to invest in, one must understand the different types of mutual funds.
The main types of mutual funds are:
- Open-end funds
- Closed-end funds
- Money market funds
- Stock funds (Equity funds)
- Bond funds (Fixed-income funds)
- Hybrid funds
Open-End Funds vs. Closed-End Funds
Open-end funds are mutual funds which allow new investors in at any time, as there is no limit to the number of shares that can be sold.
The mutual fund sells shares to new investors, dependent upon the net asset value of the share at the time of purchase.
As the value of shares increases, the fund manager will pay out in dividends or use the new money to invest further, thus expanding the portfolio.
Closed-end funds are mutual funds which have a limited number of shares available for purchase.
This type of fund is created through an Initial Public Offering (IPO) where these shares are sold as part of a portfolio.
If another investor wants to join in a closed-end mutual fund after the IPO, they must purchase a share from an investor who is already a holder in the fund and is willing to part with their share.
Money Market Funds
Money market funds are the mutual funds that come with the least amount of risk.
Due to limited risk, there are also limited rewards, but money is safe here.
A money market fund is successful if the net asset value stays at $1 per share; any earnings would then be from yields.
A money market fund is open-ended, so it has no set number of shares.
The main investment of a money market fund is short-term debt assets. Money market funds are often compared to bank accounts, due to their safety.
The main difference between a money market fund and a savings account is that the yield from a money market fund is slightly greater than the interest on a bank account would be.
Aside from security, one of the biggest benefits to money market funds is liquidity.
Due to the low risk involved in money market accounts they may be used as a sweep account, which means they collect money from sold shares and fund purchased shares.
A stock fund, otherwise known as an equity fund, is unsurprisingly a fund that invests in stocks.
While the fund is composed mainly of stocks, there may also be a small amount of cash involved.
Stock funds do not have to invest solely in the US; they can invest in the US, in both US and foreign markets, or only in foreign markets.
Stock funds may invest in a variety of different companies, may or may not collect dividends depending on the company, and come with a decent amount of risk due to market fluctuations.
There are many different types of stock funds to choose from:
- Index funds
- Growth funds
- Value funds
- Sector funds
- Income funds
- Balanced funds
- Asset allocation funds
- Hedge funds
The type of stock fund an investor chooses will be based on opportunity, growth, financial possibilities, risk, availability and other preferences.
Bond funds are otherwise known as debt funds and mainly deal with debt securities.
A bond fund usually pays dividends and also pays on appreciation of capital at periodic intervals. In contrast to individual bonds, bond funds acquire dividends more often.
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Another benefit to bond funds over individual bonds is that funds are managed by an investment professional, so the individual investor has no responsibilities in terms of management.
Also, bond funds are liquid; bonds can be sold at any time without waiting for maturity.
There are some drawbacks to bond funds, however, in comparison with individual bonds.
Most bond funds require a fee, whereas individual bonds do not. Also, there is fluctuation in the dividends for bond funds rather than the fixed rate of interest that an individual bond has.
There are 4 main types of bond funds:
- Government bonds – The least risky of the bonds due to the fact that the government is always capable of printing more money to cover debts.
- Agency bonds – These are not produced by the government, but by government agencies such as Freddie Mac.
- Municipal bonds – These are produced by smaller governments, such as states or counties. Municipal bonds are often exempt from federal taxes and sometimes even state taxes.
- Corporate bonds – These bonds are issued by corporations, not government entities. Corporate bonds are higher risk because dividends are dependent upon the corporation’s ability to pay the bond when it matures.
A hybrid fund holds a mixture of stock funds and bond funds.
The main benefit to a hybrid fund is that it offers investors an opportunity to diversify their portfolio with just one fund.
There is no formal equation to what exists within a hybrid fund; some funds require a fixed number of stocks and bonds, some will vary, and some will go between varied and fixed.
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