Yesterday, we examined how to invest in mutual funds, and I went over the reasons why mutual funds may be a good idea for you. One you make the decision to invest your hard earned capital in mutual funds, you have to decide which one and which type matches your individual investment style. For the purposes of this discussion, there are three major types of mutual funds available to investors:
- Stock mutual funds
- Bond mutual funds
- Money market mutual funds
In addition to these three types of funds, many investors prefer to invest in balanced funds which include both stocks and bonds in one fund. Another type of mutual fund are REIT funds which invest in real estate companies.
Stock Mutual Funds
Stock mutual funds, also called equity funds, invest in the shares of publicly traded companies. These mutual funds can be further classified by market capitalization (how large the company is, also called market cap), investment style, business sector, and even geographic location. Some funds combine several classifications within one fund.
Stock mutual funds often focus on buying companies whose market caps all fall within one of the five market cap ranges
- Micro-cap $50 million to $500 million
- Small-cap $500 million to $2 billion
- Mid-cap $2 billion to $10 billion
- Large-cap $10 billion to $200 billion
- Mega-cap $200 billion and up
In general, the smaller the market cap, the greater the risk but the potential reward is greater too. Do you know your personal investment risk tolerance?
The term style in the context of stock mutual funds refers to whether the fund invests in growth, value, or income stocks. Blended mutual funds invest in a mix of all three. Growth stocks are those that are expected to grow their profits and stock price according to analysts. Value stocks have a stock price that is considered undervalued based on it’s net profit and income stocks produce income from dividends.
Sector mutual funds invest only in companies that do business in a particular industry, such as retail, energy, financial services, healthcare, or technology.
Some stock mutual funds invest only in businesses based in particular geographic regions, such as Latin America, Asia, Europe, or even specific countries such as Brazil, Russia, China, or Argentina.
Bond Mutual Funds
Bond mutual funds hold baskets of corporate or government bonds. If you buy a bond mutual fund, you get the stable performance and returns of the underlying bonds that the fund owns, but you don’t have the hassle of buying individual bonds. What you don’t get, though, is a guaranteed return of your principal. Bond mutual funds break down into a wide variety of subcategories based on their term, who issues the bond, a bond’s tax status, and what region the bond’s issuer resides in.
Some bond mutual funds buy only short-term, intermediate-term, or long-term bonds.
Some bond mutual funds buy only bonds issued by the federal or state governments, city governments (municipal bonds), or corporate bonds issued by companies.
Taxable bond mutual funds hold bonds that require owners to pay taxes on interest income; tax-exempt funds hold bonds that pay tax-free interest. Taxable bond funds usually pay higher interest rates than tax-exempt bond funds.
Region bond mutual funds, or foreign bond mutual funds, buy bonds issued by governments or corporations in specific regions or countries other than the USA. Investors tend to favor foreign bond mutual funds that focus on regions (or countries) with stable political and economic climates, such as Europe and Japan, though the definition of “political stability” can easily change.
Mutual fund companies often offer bond mutual funds that combine two or more of these classifications. For example, a long-term government bond mutual fund would own bonds issued by federal or state governments with terms of 10 years or more.
Money Market Mutual Funds
Money market mutual funds invest in short-term debt that pays interest. Mutual fund companies often recommend these funds to clients as an alternative to savings accounts, since money market mutual funds are nearly as risk-free as savings accounts and offer higher interest rates than typical savings accounts.
Though money market mutual funds are very safe, they’re not a great place to keep money long term if you want to grow your principal.
Balanced Mutual Funds
Balanced mutual funds invest in a mix of stocks and bonds. Buying such a fund can be a simple, convenient way to build a balanced investment portfolio with just one holding.
REIT Mutual Funds
REITs (Real Estate Investment Trusts) are corporations that develop and/or manage real estate properties such as large apartment complexes or real estate developments. REIT funds are mutual funds that invest exclusively in the stocks of these corporations. Investors buy REITs as a way of including real estate in their investment portfolios without actually having to own real estate property.
Where You Can Acquire These Mutual Funds
You can buy mutual funds directly from the mutual fund company or better yet, set up an investment account at one of the brokerage houses listed below. By setting up an account at an online brokerage, you aren’t limited to the types of investments you can purchase.
- Scottrade – you can thousands of different mutual funds.
- optionsXpress – one of the easiest online brokerages to set up.
- TradeKing – offers regular trades and broker assisted trades for only $4.95.
- tradeMonster – offers mobile trading.
- optionshouse – this is basically the least expensive online brokerage for investors.
- Zecco – has commission free trades available.