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There are many varieties of mutual funds but most types could be reduced to basically three categories.
Stock Mutual Fund
A stock mutual fund will generally consist of company stock only. The mutual fund may be further subdivided by the size of the companies, the nationality of the companies, or the sector of the market the companies do business in. The nature of the mutual fund may be as varied as the stocks that they contain.
For example, let’s consider a mutual fund called a “small-cap growth fund.” This is first and foremost a stock fund. The fund manager begins with the universe of stocks and then screens out all stocks that are not small-capitalized companies. Next, the manager screens out companies that are not positioned for long-term capital growth. Finally, what they’re left with is a group of stocks that fit as possibilities for their fund. Sometimes, there will be many, many screens that eventually create a mutual fund that has a very specific objective on how to grow money for their investors.
Stock funds, as a rule, are considered somewhat more aggressive in terms of risk and reward than bond funds. This is primarily because of the volatile nature of stock funds versus bond funds or asset allocation funds.
Bond Mutual Fund
Bond mutual funds are the same mechanically. A bond mutual fund is simply a mutual fund that consists of bonds.
What is a bond? A bond is a loan. When your mutual fund buys a bond, you step in as a quasi-owner of the bond. You are essentially put in the place of a lender. The obligation of the borrower is to pay the note back, which you hold by virtue of holding the mutual fund full of notes. Borrowers of the fund’s money might be corporations, governments, or municipalities. Each of these not only promises to pay back the money invested with them, but interest as well.
So, when you buy a bond mutual fund you are buying the debt, with interest.
Generally, among all kinds of mutual funds, bond funds are regarded as more conservative than their stock fund companions. This is because the prices of bond mutual funds typically are less volatile than stock mutual funds.
Asset Allocation Funds
Asset allocation funds are an all-purpose mutual fund that doesn’t spotlight any singular type of investment. Instead, these funds’ focus is to provide diversification among stocks, bonds, cash, hedging instruments, gold, or even real estate.
Their objective is to spread the investor’s assets among more than one markets so that the investor is further diversified from risk of loss in any one type of market.
For example, instead of owning a fund that contains only stocks, an asset allocation fund may add bonds to the fund. This practice hopefully gives an investor more shelter from loss of principle than he/she would have had otherwise.
Asset allocation funds, sometimes called balanced funds, may vary greatly in terms of how they diversify. One asset allocation fund may hold more high-quality bonds than any other security type. The next fund may contain far more stocks in the mutual fund than any of the other investment options. Either way, the goal is to diversify.
There are many types of mutual funds. The key is to find the ones that work for you and your portfolio.
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