Mutual funds are a diverse investment. Once you buy into one, you have a hands-off investment that the mutual fund manager oversees. While buying mutual funds may be simple, choosing the right fund may be more challenging.
Each mutual fund diversifies your risk, but certain funds carry more risk than others. Choosing the right mutual fund requires an understanding of the different options and how you earn from them. Once you choose the type of fund, you’ll still have research to do. You must understand the fund’s fees and rate of return.
Read on to learn more about the types of mutual funds.
Equity mutual funds invest in stocks from multiple companies. These funds have a greater risk, but also have greater returns. Within equity funds there are multiple choices:
- Industry funds – Industry or sector funds invest in one area. For example, healthcare funds invest in all healthcare companies. There are mutual funds for almost any industry. Just make sure you do your research ensuring it’s properly managed.
- Growth funds – Mutual fund managers choose stocks they believe will ‘grow’ or that have potential. These stocks are quickly increasing in price. The fund manager will buy the funds now and sell them when there’s a significant profit. Growth funds have high fees because of the amount of work involved in buying and selling the stocks.
- Value funds – Mutual fund managers choose stocks valued at less than their worth. Managers hold on to these funds for a long time, waiting for them to grow. Because there isn’t as much buying and selling involved, the fees on value funds are lower.
- Funds by company size – Mutual fund managers may focus on small, mid, or large-cap funds, which refers to the company’s market value.
Young investors often choose equity funds for their higher returns. Because young investors have more time to ride out the stock market’s waves, they can take the risk and earn potentially higher earnings.
Bond mutual funds invest in bonds or fixed-income vehicles. Investors earn regular (fixed) income from the bond’s interest. Some investors use the bond’s interest income to offset stock investments that rise and fall.
Because bond funds are less risky, they have a lower rate of return than equity funds when the market is doing well. Investors nearing retirement often choose bond funds to avoid the risk of a total loss, but to keep earning an income.
Money Market Funds
Does cash in your portfolio make you feel better? Money market funds help keep a portion of your portfolio liquid. Money market funds may invest in highly rated government or corporate bonds with short maturities. While there are very little earnings in money market funds, hanging onto the capital can be a strategic move in your portfolio.
Index funds are the most popular type of mutual fund. They try to mimic or match specific index’s earnings, such as the S&P 500. These funds are passively managed and can match funds in just about any index. Some funds include all the stocks in an index, and others only include some of them. Because index funds aren’t based on opinion, but rather actual index performance, they typically have lower fees.
Hybrid funds or balanced funds put pieces of each fund together to balance out the risk. The funds are a balance of equity and bond funds. You’ll know the mix of investments, such as 60% bonds, 40% stocks or vice versa before buying.
Choosing the Right Mutual Fund
How do you choose the right mutual fund? First, think of diversification. You may start with a less risky fund, such as a bond fund, and as you get a comfortable move into riskier funds with greater returns. The right fund is the one you feel comfortable with and that provides eventual returns.
If you are unsure about which funds to invest in, consult with a financial advisor. Remember, if you invest in mutual funds in your retirement account, whether 401K or IRA, you may pay tax penalties if you sell the funds before retirement.
Mutual funds can be a great addition to any portfolio you want to diversify. Do your research; know the funds’ loads, rate of return, and the manager’s experience before purchasing. You’ll minimize your losses and ensure a properly managed fund when you take your time, doing your research.