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A Look at Mutual Fund Categories
- Aggressive Growth and Small-Cap Funds
- Growth Funds
- Growth and Income Funds
- Balanced Funds
- Sector Funds
- Bond Funds
- Money Market Funds
- Global and International Funds
With more than 7,000 mutual funds available today, selecting the ones to include in your portfolio is a tricky business. Overwhelmed by the sheer number of funds, new investors may be understandably confused. People invest in mutual funds largely because they don't have the time to examine thousands of individual securities, yet selecting mutual funds doesn't seem any easier.
True, picking the right funds will take some time. But once you have some understanding of the different fund categories -- which determine the kinds of securities fund managers select for their funds -- the industry's messy and seemingly endless differentiation will clarify itself. You can then devise a mutual fund investment strategy that will work for you, bearing in mind your time horizon and ability to withstand fluctuations in the value of your portfolio.
Categories for Different "Tastes"
Despite the fund industry's endless differentiation, equity mutual funds boil down to five large groups: aggressive growth funds, growth funds, growth and income funds, balanced funds, and sector funds. Besides those, there are also categories of bond funds, money market funds,* and global and international funds.
* Aggressive growth and small-cap funds are among the most aggressive equity funds. Aimed at maximizing capital gains, these funds invest in companies with the potential for rapid growth, such as companies in developing industries, small but fast-moving companies, or companies that have fallen on hard times but appear due for a turnaround. Some aggressive growth funds use several investment strategies, which may include options and futures, in an effort to achieve superior returns. These funds can be very volatile in the short term, but in the long run they tend to outperform the broader market and have delivered excellent returns to their shareholders. Aggressive growth funds are more suitable for long-term investors with a time horizon of 10 years or longer.
* Growth funds also strive for capital appreciation by investing in companies that are positioned for strong earnings growth. Funds in this group vary widely in the amount of risk they take. But in general, they are less risky than aggressive growth funds because they normally invest in well-established companies. Growth funds also tend to deliver good long-term returns but with relatively lower volatility than aggressive growth funds. Neither aggressive growth funds nor growth funds strive for dividend income. In fact, the companies they invest in often do not pay dividends to their shareholders but reinvest the earnings to fuel future growth.
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Equities
* Aggressive Growth
* Small Cap
* Sector
* Growth
* Asset Allocation
* Growth and Income
* Balanced
* Global
* International
* Emerging Market
* Country/Regional
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Fixed Income
* High Yield
* Mortgage Backed
* Government Agency
* Long-Term Government
* Long-Term Corporate
* Tax-Exempt
* Short-Term Bond
* Money Market
* Tax-Exempt Money Market
* International Bond
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* Growth and income funds strive for both dividend income and capital appreciation by investing in companies with solid records of dividend payments and capital gains. Most growth and income funds strive for yields equal to or better than the money market average and to provide capital appreciation that at least beats inflation. Some growth and income funds emphasize growth while others emphasize income. Growth and income funds are often less risky and less volatile than pure growth funds, and tend to lag behind the overall market. The investment time horizon of growth and income fund investors can be anywhere from 2 to 10 years.
* Balanced funds offer one-stop shopping by combining stocks and bonds in a single portfolio. Balanced funds are more conservative than the previously discussed categories and usually invest in blue-chip stocks and high-quality taxable bonds. They normally hold up well in rough markets, because when their stock investments fall, their bonds may do well and vice versa. Because they offer broad diversification, balanced funds are often suitable for people with a small amount of cash to invest.
* Sector funds concentrate on one industry, such as technology, financial services, or consumer goods, or focus on certain commodities, such as gold, gas, or oil. Sector funds are used by more experienced investors who are willing to pay close attention to the market. Because they are less diversified than the broader market, they are often more volatile.
* Bond funds can be divided into four broad categories: tax-exempt, taxable, high quality, and high yield. Within these categories, funds are also segmented by maturities, type of issuer, and credit quality of bonds in which they invest. Tax-exempt bond funds, preferred by people in higher tax brackets, buy bonds issued by state and municipal agencies, while taxable bond funds may invest in all other debt securities. High-quality bond funds stick to government and top-rated corporate or municipal bonds that offer relatively lower interest. High-yield bond funds buy lower-rated or non-investment grade corporate or municipal bonds, or "junk bonds," which offer higher interest to compensate for the higher risks that investors take. While bond funds in general are less risky than stock funds, they still carry varying degrees of risk in terms of capital loss and default risk.
Compare the difference in fluctuating value and long-term performance among different fund categories. Sector funds generally have performed better, but with wider fluctuations, than growth and income and bond funds. Past performance is no guarantee of future results.
Source: Standard & Poor's.
* Money market funds invest in short-term money market instruments, such as U.S. Treasury bills, commercial paper, certificates of deposit, and repurchase agreements. Striving to maintain a stable share price of $1, money market funds offer maximum safety and liquidity, as well as a yield that's generally higher than that of bank deposits.
* Global and international funds can help you diversify your portfolio into a wide array of foreign stocks and bonds. The difference between the two groups is that global funds may buy a mix of U.S. and foreign stocks, whereas international funds invest exclusively overseas. Under the two fund groups, there are regional funds and country funds designed to take advantage of specific investment opportunities in the world's developed and emerging countries. In terms of risk ratio, global and international funds vary widely from lower-risk funds that invest in established markets to higher-risk emerging market funds.
Watch Your Basket
The old cliche, "Don't put all your eggs in one basket," applies to mutual funds as much as any other type of investing. By investing in only one fund category, you may subject your assets to an undue amount of risk. One way to help minimize risk is to practice diversification, or spreading your assets among a variety of funds within different categories.
Understanding mutual fund categories is only the first step in mutual fund investing. The next step is to match your goals, time frame, and risk tolerance to appropriate fund categories.
*An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
Points to Remember
1. Mutual fund categories determine the types of securities that mutual fund managers select for their funds.
2. Some equity fund categories are aggressive growth, growth, growth and income, balanced, sector, bond, money market, global, and international.
3. Bond funds include taxable and tax-exempt funds and are also segmented by maturity, issuer, and credit quality.
4. Investors should match their objectives to a particular category but be cautious about focusing too heavily in one area.
5. Diversifying among funds is one way to minimize risk in your portfolio.
Copyright 1999 The McGraw-Hill Companies, Inc.
Standard & Poor's including its subsidiary corporations ("S&P") is a division of the McGraw-Hill Companies, Inc. Reproduction of Standard & Poor's articles in any form is prohibited except with the written permission of S&P. Because of the possibility of human or mechanical error by S&P's sources, S&P or others, S&P does not guarantee the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information.
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