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The Financial Planning Center

Comprehensive Financial Planning

Mutual Fund Categories

Mutual Fund Education

Why Mutual Funds?

What is a Mutual Fund?

How Mutual Funds Work

Mutual Fund Risk

Advantages/Disadvantages

Mutual Fund Expenses

Costs you Wont Find in a Prospectus

Mutual Fund Categories

Fund Management Styles

How an Investment in a Mutual Fund Makes Money

Investment Company Act of 1940

Where to Purchase Funds

Future Value Chart

Mutual fund categories

Mutual funds fall into the following categories: money market funds, bonds funds, stocks funds, balanced funds, and asset allocation funds.

Stock funds

As the name implies, stock mutual funds invest mainly in common stocks.  These stocks may be sold on the New York Stock Exchange, the NASDAQ or other exchanges.

The objective of a stock fund is long-term capital appreciation versus generating income (dividends) more common with bond funds.  However, stock funds may generate modest dividends from the stocks in the portfolio and from short-term cash investments.  These stock tend to be larger capitalized stocks versus smaller growth stocks.

There are four basic types of stock funds.

Stock Fund Types

1. Large Cap: Primarily invests in "Blue-chip" companies - large, well-known industrials, utilities, technology, and financial services companies with large market capitalization.  Large cap stocks are perceived to be less risky than smaller capitalized companies.

2. Mid Cap: Primarily invests in companies whose market capitalization is smaller than large caps but larger than small caps.   Mid caps are generally considered more risky than large cap stocks but have a higher return expectation.

3. Small Cap: Primarily invests in emerging companies, thought to have potential for future growth and profit.  Small caps are generally considered the riskiest stocks compared to larger capitalized firms but carry the expectation of higher returns.  Small cap funds are subject to greater volatility than those in other asset categories.

4. International:  Primarily invests in stocks traded on foreign exchanges but purchased in the United States by U.S. fund companies.  International funds are subject to additional risks such as currency fluctuation, political instability and the potential for illiquid markets.

5. Sector:  Primarily invests in specific industry sectors such as technology, financials, health, or energy.  Since sector funds focus their investments on companies involved in a specific industry sector, the funds may involve a greater degree of risk that an investment in other mutual funds with greater diversification.

Many investors buy stock mutual funds because, historically, stocks have outperformed other types of investments over the long term. However, the value of the stocks in the fund's portfolio may go up or down as the market rises or declines. Remember, past performance is no guarantee of future results.

Bond funds

Bond funds¹ invest in various types of bonds - issued by corporations, municipalities, and the U.S. government. Bond mutual funds are designed mostly to provide investors with a steady stream of income² versus capital gains.

Bond Funds:

1. Invest in bonds, which are debt securities, or IOUs, issued by corporations or governments in exchange for money loaned to them. Generally, the issuer agrees to repay the loan by a specific date and to make regular interest payments to the lender until then.

2. Are a basket of bonds with different durations, yields, credit quality, and values.  Because of this, bond funds never mature as would be the case with buying an individual bond.  

3. Share value and dividends will fluctuate as interest rates fluctuate and new bonds are purchased or others are sold or mature.

4. Produce profits that consist primarily of dividend distributions.

5. May generate modest capital gains.

6. Fluctuate in value, so it is possible to sell shares at a higher or lower price than you paid for them.

Bond Fund Types:

• Government:  Primarily invest in bonds issued by the U.S. Department of Treasury as well as various federal agencies.  Government bonds are generally taxable.

• Municipal:  Primarily invest in municipal bonds issued by state and local governments and their agencies to fund projects such as schools, streets, highways, hospitals, bridges, and airports.  Municipal bonds can be insured or non-insured securities.  Income generated from municipal bonds may be tax free at both the federal and state level (consult the funds prospectus). 

• Corporate:  Primarily invest in bonds issued by corporations to help fund business activities.  Income from corporate bonds is taxable.

¹ Bond fund shares are not guaranteed and will fluctuate with market conditions and interest rates and include a greater risk to principal than Certificates of Deposit. Shares, when redeemed, may be worth more or less than their original cost.

² Income may be subject to the Alternative Minimum Tax (AMT) and capital appreciation from discounted bonds may be subject to state and local taxes.

Money market funds

Money market funds invest in short-term securities such as Treasury bills. Most money market funds offer a higher rate of interest than bank savings accounts, and some are free of federal or state taxes. But unlike bank savings accounts, money market funds are not FDIC insured.

Money market mutual funds are designed to be more stable than stock or bond funds. Money market funds are designed to provide steady dividend income on the investment amount, although the yield may fluctuate daily.

Taxable:  Invest in short-term obligations from corporations.

Tax-free:  Invest in short-term obligations from government entities.

Balanced Funds:

• Invest in stocks, bonds, and cash investments, in varying proportions.

• Produce dividend and capital gain distributions and share price appreciation in proportion to their allocation among the three major asset classes.

Asset Allocation Funds:

In an asset allocation fund, the manager will diversify the assets among each category: cash, bonds, and stocks and weight them according to the portfolio strategy.  The manager will redistribute the weightings according to market conditions.  Portfolio strategies generally differ according to risk tolerance:

• Aggressive Growth Strategy Portfolio

• Growth Strategy Portfolio

• Growth  and Income Strategy Portfolio

• Income Strategy Portfolio

Asset allocation funds are usually made up of a combination of other mutual funds within the same fund family.  As market conditions change, the manager has the discretion to reduce exposure in one fund and increase it in another.  Just about all mutual fund families allow you to switch between funds in the same family and class (A, B, or C shares) without incurring any costs.

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