However you choose to read it, I'd love to hear your comments.
Obligatory boilerplate:
This note was sent to people on The Investment FAQ's email list.
Subscribers to this list receive very occasional messages with
information from The Investment FAQ, which of course is your clear,
concise, and unbiased guide to personal finance and investing.
To unsubscribe or change email addresses, hit reply or this page:
http://invest-faq.com/email.html
The headers on this msg will show @stockmaster.com addresses.
StockMaster is my host, as well as a fine quote and chart provider.
You can use my StockMaster address, but I prefer lott@invest-faq.com.
-----------------------------------------------------------------------------
Subject: Mutual Funds - Types of Funds
Last-Revised: 12 Aug 1999
Contributed-By: lott@invest-faq.com
This article introduces the most common investment fund types. A type
of fund is typically characterized by its investment strategy (i.e.,
its goals). For example, a fund manager might set a goal of generating
income, or growing the capital, or just about anything. (Of course
they don't usually set a goal of losing money, even though that might
be one of the easist goals to achieve :-). If you understand the types
of funds, you will have a decent grasp on how funds invest their
money.
When choosing a fund, it's important to make sure that the fund's
goals align well with your own. Your selection will depend on your
investment strategy, tax situation, and many other factors.
Money-market funds
Goal: preserve principal while yielding a modest return. These funds
are a very special sort of mutual fund. They invest in short-term
securities that pay a modest rate of interest and are very safe. See
the article on money-market funds elsewhere in this FAQ for an
explanation of the $1.00 share price, etc.
Balanced Funds
Goal: grow the principal and generate income. These funds buy both
stocks and bonds. Because the investments are highly diversified,
investors reduce their market risk (see the article on risk elsewhere
in this FAQ).
Index funds
Goal: match the performance of the markets. An index fund essentially
sinks its money into the market in a way determined by some market
index and does almost no further trading. This might be a bond or a
stock index. For example, a stock index fund based on the Dow Jones
Industrial Average would buy shares in the 30 stocks that make up the
Dow, only buying or selling shares as needed to invest new money or to
cash out investors. The advantage of an index fund is the very low
expenses. After all, it doesn't cost much to run one. See the article
on index funds elsewhere in this FAQ.
Pure bond funds
Bond funds buy bonds issued by many different types of companies. A
few varieties are listed here, but please note that the boundaries are
rarely as cut-and-dried as I've listed here.
Bond (or "Income") funds
Goal: generate income while preserving principal as much as
possible. These funds invest in medium- to long-term bonds issued by
corporations and governments. Variations on this type of fund include
corporate bond funds and government bond funds. See the article on
bond basics elsewhere in this FAQ. Holding long-term bonds opens the
owner to the risk that interest rates may increase, dropping the value
of the bond.
Tax-free Bond Funds (aka Tax-Free Income or Municipal Bond Funds)
Goal: generate tax-free income while preserving principal as much as
possible. These funds buy bonds issued by municipalities. Income from
these securities are not subject to US federal income tax.
Junk (or "High-yield") bond funds
Goal: generate as much income as possible. These funds buy bonds with
ratings that are quite a bit lower than high-quality corporate and
government bonds, hence the common name "junk." Because the risk of
default on junk bonds is high when compared to high-quality bonds,
these funds have an added degree of volatility and risk.
Pure stock funds
Stock funds buy shares in many different types of companies. A few
varieties are listed here, but please note that the boundaries are
rarely as cut-and-dried as I've listed here.
Aggressive growth funds
Goal: capital growth; dividend income is neglected. These funds buy
shares in companies that have the potential for explosive growth
(these companies never pay dividends). Of course such shares also have
the potential to go bankrupt suddenly, so these funds tend to have
high price volatility. For example, an actively managed
aggressive-growth stock fund might seek to buy the initial offerings
of small companies, possibly selling them again very quickly for big
profits.
Growth funds
Goal: capital growth, but consider some dividend income. These funds
buy shares in companies that are growing rapidly but are probably not
going to go out of business too quickly.
Growth and Income funds
Goal: Grow the principal and generate some income. These funds buy
shares in companies that have modest prospect for growth and pay nice
dividend yields. The canonical example of a company that pays a fat
dividend without growing much was a utility company, but with the
onset of deregulation and competition, I'm not sure of a good example
anymore.
Sector funds
Goal: Invest in a specific industry (e.g., telecommunications). These
funds allow the small investor to invest in a highly select
industry. The funds usually aim for growth.
Another way of categorizing stock funds is by the size of the
companies they invest in, as measured by the market capitalization,
usually abbreviated as market cap. (Also see the article in the FAQ
about market caps.) The three main categories:
Small cap stock funds
These funds buy shares of small companies. Think new IPOs. The stock
prices for these companies tend to be highly volatile, and the
companies never (ever) pay a dividend. You may also find funds called
micro cap, which invest in the smallest of publically traded
companies.
Mid cap stock funds
These funds buy shares of medium-size companies. The stock prices for
these companies are less volatile than the small cap companies, but
more volatile (and with greater potential for growth) than the large
cap companies.
Large cap stock funds
These funds buy shares of big companies. Think IBM. The stock prices
for these companies tend to be relatively stable, and the companies
may pay a decent dividend.
International Funds
Goal: Invest in stocks or bonds of companies located outside the
investor's home country. There are many variations here. As a rule of
thumb, a fund labeled "international" will buy only foreign
securities. A "global" fund will likely spread its investments across
domestic and foreign securities. A "regional" fund will concentrate on
markets in one part of the world. And you might see "emerging" funds,
which focus on developing countries and the securities listed on
exchanges in those countries.
In the discussion above, we pretty much assumed that the funds would
be investing in securities issued by U.S. companies. Of course any of
the strategies and goals mentioned above might be pursued in any
market. A risk in these funds that's absent from domestic investments
is currency risk. The exchange rate of the domestic currency to the
foreign currency will fluctuate at the same time as the investment,
which can easily increase -- or reverse -- substantial gains abroad.
Another important distinction for stock and bond funds is the
difference between actively managed funds and index funds. An actively
managed fund is run by an investment manager who seeks to "beat the
market" by making trades during the course of the year. The debate
over manged versus index funds is every bit the equal of the debate
over load versus no-load funds. YOU decide for yourself.
-----------------------------------------------------------------------------
More obligatory boilerplate:
This note is not investment advice, nor a solicitation to sell shares
in any company. The article text is copyright (c) 1999 by Christopher
Lott. Feel free to save, print, etc. this message for your own
personal use, or pass it on to a friend. Please do not post this
note on any email lists or news groups. If you see this note posted
or used inappropriately, please contact me immediately.
For a full set of disclaimers and terms of use statements, visit
http://invest-faq.com/about.html
Thanks again for your interest.
chris...
-- Christopher Lott Compiler of The Investment FAQ lott@invest-faq.com http://invest-faq.com/- To unsubscribe from this list: send the line "unsubscribe linux-kernel" in the body of a message to majordomo@vger.rutgers.edu Please read the FAQ at http://www.tux.org/lkml/