Thursday, July 16, 2009

The different types of mutual funds

This is the second part of a series on mutual funds . Like i said on the previous post, mutual funds are the investor's best friend. Especially if you want the easy approach to investing. However mutual funds come in a range of flavour ranging from the safe and conservative one to the risky and high yield ones. As a result in order to understand what type is better for you, you will need to understand the concept of risk and risk tolerance. That is how much risk can you accept in you investment.

The simple rule goes like this. The riskier the mutual fund the higher the risk and the more conservative and safe it is the lower the return.

What are the types of mutual funds?

1. Equity Funds

Equity funds invest only in equities. However you may have funds that invest across the board or you may have funds that are more specialised. Some funds invest in all different types of companies and of all sizes and as a result offer some diversification. However some mutual funds invest in special sector of the economy such as green, gold or technology. Others might invest only in large, medium or small caps companies. While these funds may offer some potential for growth it is unwise to invest all your money in a fund that invest in one sector or one type of company only. If you are really interested i would suggest investing only a small amount like 5 % of your money.

I would strongly suggest investing in a fund that offer some diversification in different sectors and in different company sizes. If you are really interested invest a small part of your money in a fund like gold, green , etc that has some growth potential.

2.Bond Funds

as I have mentionned in the post on deversification and in the post on bonds, bonds offer some advantage to the investor. Bonds can bring some stability to your portfolio and bring regular income in opposition to stocks which may not give regular payment as dividends payment depend on management. A bond fund would thus invest in bonds and since bonds pays biannual coupon payment the bond will give you regular payment.

A bond fund is thus the ideal investment for a retiree for example who would have had to invest in bonds so as to be able to generate regular income. Otherwise he would have had to design a bond ladder which may be beyond the normal investor's capacity.

Like equity some mutual funds invest accross the board in a wide range of bonds of various maturity, risk and issuers. This afford some diversification and risk reduction.

However there are also a lot of mutual funds that invest in a lot of different types of bonds. some would invest only in corporate bonds, muni bonds, government bonds, junk bonds, etc. These bonds may offer some great returns but because they are specialised there is greater risk. I would advise you to invest only in a general bond fund or to invest only a small amount of money in a special fund that you like. However remember that the most fund you invest in, you increase the fees and commissions that you have to pay annually.

3. Money Market Funds

The money market is the market that deals in the trading of short term securities. That is securitie that mature in one year or less such as treasury bills, cds, etc. As you might guess such securities would offer the lowest yield but are the most secure and safe. There is no chance that you can lose your money with a money-market mutual fund. If you have some money that you cannot afford to lose but you want to earn something with it until you need it then the money-market fund is ideal for you. It gives more earning than the CDs or savings accounts.

4. Balanced Funds

The balanced mutual fund can be said to be a mixture of the equity and bond mutual fund. It provide the advantage of long term growth and gain from stocks and the possibility of regular income with bonds. I would therefore strongly reccomend this type of fund for the average investor since it provide the advantages of both stocks and bonds.

Or you could buy in one general bond fund and one general equity fund.

5. Index Funds

The index is simply an index fund that is trying to emulate another index. For example an index fund can have the same shares of all the companies in the Dow Jones. The fund will thus rise and fall in value with the Dow Jones. You can read a post here on index fund.

This is also a good way to invest. Since stocks grow in the long term an index fund will grow in value with time.

6. Speciality funds

These mutual funds invest in stocks or investment instruments of a particular kind. You might have an african stock mutual fund, a chinese stock mutual fund, a gold stock mutual fund, a chinese companies corporate mutual fund, etc. The list is long. I would however strongly discourage investing in those funds as you lack diversity and they are generally riskier. If you really have to invest, invest only a small part of you money.

If you would like to share your experience with us or to ask a question, leave a comment below.

Introduction to diversification
What is an index fund?
What is a mutual fund?

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1 comment:

  1. Hi,

    You have posted valuable information on mutual funds.

    Knowing how to invest in stocks is the perfect way to protect yourself as well as your investment. In order to minimize the financial risk at the same time you increase your potential gain it is better to be an active participate in your portfolio. Know what the market is that you are investing in, which stocks and what types of factors have a direct effect on that particular market as well as the market in general this will help to reduce the risk of losing your investment. You do not need to be an expert in stock investing in order to be actively involved but you will probably need to spend some time in researching terms, trends, and how to spot things that will potentially bring about a greater return for you and your investment.