Types of Mutual Funds You Must Know

Mutual funds are a type of investment vehicle designed to allow investors to invest in many different types of securities. The most common form of fund investing today involves buying shares or units in one or more companies, which may be publicly traded on an exchange such as the New York Stock Exchange, and then holding those investments for a while until they mature. Mutual funds can also buy bonds issued by governments, corporations, banks, insurance companies, real estate trusts, mortgage-backed securities, commodities, currencies, and other financial instruments. 

They can hold these assets either individually or together in portfolios called "funds." Funds are usually managed by professional money managers who use various techniques to beat market returns over long periods. The term "mutual" refers to two things: it means that there is no central organization running the fund; instead, each investor owns their share of the fund's capital; and it implies that all shareholders have equal voting rights.


This last point is important because if you put your entire life savings into just one stock, you would not want someone else to have control over how much of your hard-earned cash was invested in that company. In contrast, when you purchase shares in a mutual fund, you give up ownership but gain access to diversified holdings through the management team. As a result, you get exposure to multiple stocks without giving up any control over where your money goes.

Types of mutual funds

There are three basic categories of mutual funds: equity funds, bond funds, and balanced funds. 

Equity Funds

Equity funds focus primarily on equities. These funds typically include large-cap growth, small-cap growth, value, international, emerging markets, dividend-paying, etc.

Advantages

  • Equity funds offer higher potential returns than fixed-income funds due to their ability to outperform the overall market.

Disadvantage

  • Equities tend to fluctuate significantly from month to month and year to year, so they require active trading. If you do not like actively managing your portfolio, this could be a disadvantage.


Bond Funds

Bond funds tend to follow fixed income strategies. Typically this includes government debt, corporate debt, municipal debt, inflation-protected securities, convertible securities, preferred securities, high yield, short duration, etc.

Advantages

  • Fixed Income tends to move less dramatically than equities. It has lower volatility and therefore provides a safer place to park your money.

Disadvantage

  • Bond funds generally pay out low yields compared to equities.

Balanced Funds

A balanced fund sought to achieve its objectives using both equity and fixed income approaches. It will generally seek to maintain a portfolio balance between 50% equity and 50% fixed income.

Advantages

  • Balanced funds allow investors to benefit from the best attributes of both fixed income and equities.

Disadvantage

  • Balancing risk and reward requires skillful asset allocation decisions.

The following table shows the differences among the three main categories of mutual funds.

Benefits of Mutual Funds

1) Diversification - By owning several different kinds of investments within a single account, you reduce the chance that any individual security will go down in price while others rise. For example, suppose you owned 100 shares of IBM at $100 per share and another 100 shares of Microsoft at $50 per share. You might find yourself selling off half of your IBM shares, leaving you with only 50 shares of IBM and 50 shares of MSFT. But what happens if Microsoft rises to $150? Your original position now looks precarious since you're left with only 25 shares of IBM and 75 shares of MSFT. On the other hand, if you had held onto your whole initial position, you'd still end up with 100 shares of IBM and 100 shares of MSFT. That way, even though you lost half of your original investment, you didn't lose everything. Instead, you've been able to spread your risk across two different positions. This is called diversification.

2) Professional Management - A professional manager can help you make better investing choices by providing advice based upon their experience and expertise. In addition, managers may have access to information about companies that aren't available to ordinary investors, such as quarterly earnings reports, insider buying/selling activity, company management changes, new products being developed, mergers & acquisitions, etc. Managers also use sophisticated computer programs to analyze trends and predict future performance. These tools are used to determine how much exposure each stock should receive relative to all stocks in an index. The goal is to create a well-balanced portfolio that invests most assets in common stocks rather than bonds or cash.


3) Tax Advantages – When you invest through a professionally managed mutual fund, you don’t need to worry about taxes because it's taken care of for you. If you own securities directly, then you'll be responsible for paying capital gains tax on profits when they exceed certain thresholds. Also, dividends received from publicly traded corporations must be reported on IRS Form 1099. However, there are exceptions to these rules. See Publication 590.

4) Liquidity - With mutual funds, you get paid every month whether you sell anything or not. So, unlike direct ownership, you won't have to wait until you want to liquidate before getting your money out.

5) Accessibility - Most people who work full time cannot devote enough hours to research their investments properly. They rely heavily on professionals like financial advisors, brokers, and analysts to do this type of homework for them. Because mutual funds are offered through brokerage firms, you usually don't have to pay additional fees to buy and manage them.

6) Lower Costs - Since mutual funds are sold through brokerages instead of directly through Wall Street banks, costs tend to be lower. Brokerage commissions range anywhere from 0% to 1%, depending on the particular plan chosen.

Cons

1) Lack Of Control - Mutual Funds give up control over your money to someone else. While this gives you more flexibility, it means that you no longer have ultimate authority over your finances. It's important to understand that you cannot always count on receiving monthly statements showing exactly how your money has performed. There could be times when you miss critical market moves due to a lack of timely communication between you and your advisor.

2) Limited Number of Investment Choices - As mentioned above, many mutual funds offer only one kind of investment: Common Stock. This limits your ability to diversify your holdings across different asset classes. For example, if you're interested in real estate but find yourself limited to just equities, you might end up with too little exposure to other types of investments.

Frequently Asked Questions About types of mutual funds

Q: What do I get out of my 401?

A: Most employers match contributions made into their employees' retirement plans. So, if you contribute enough money to your plan, you could potentially earn more money back over time! However, there are some things to consider before deciding whether or not to participate in this type of program. First, many people who work full time already have adequate savings set aside for retirement, so contributing additional amounts would likely result in less money saved overall. Second, matching contributions aren't always offered to everyone; therefore, you won't necessarily benefit unless you enroll. Third, once you reach age 70 ½, you no longer qualify for employer matches. Finally, remember that these benefits are taxable income. Therefore, you'll want to consult with a financial advisor regarding the best strategy for maximizing your return without incurring unnecessary taxation.

What are Mutual Funds?

Mutual Fund: An MF is a pool of money contributed by individuals, institutions, governments, and foreign countries. It invests the pooled money in various asset classes like equities, fixed income instruments, real estate, commodities, hedge funds, private equity, venture capital, and derivatives. The Securities Exchange Commission regulates MFS. They provide shareholders with liquidity and stability. Investors buy units of MFs to gain exposure to specific sectors of the economy. For example, large institutional investors might purchase shares of General Electric Company, while small individual investors might purchase shares of Apple Inc.

Bottom Line

The main advantage of investing through an MF is that they allow you to invest in multiple assets at once. You can also take advantage of tax-deferred growth opportunities. The disadvantage is that you don't own any part of the company whose stock you purchased. Instead, you simply hold a share certificate representing ownership rights. Another drawback is that most MFs charge high fees compared to traditional brokerage accounts.