Types of Mutual Funds
Including, more recently, alternative energy mutual funds!
There are many different types of mutual funds.
Some such as balanced mutual funds contain a mix of share and bond investments, typically 60% shares to 40% bonds.
The discussion below focuses on 'pure' stock mutual fund types, but the distinction between the types may be somewhat artificial as the terms are commonly used by fund managers for marketing purposes.
Growth Mutual Funds
Growth stock mutual funds have as their goal capital growth, but are happy to get some dividend income. These types of mutual funds buy shares in companies that are growing rapidly but are probably not going to go out of business too quickly.
Whereas with more aggressive growth funds dividend income is neglected. These funds buy shares in companies that have the potential for explosive growth.
Of course such stock may also implode so these funds tend to have high price volatility.
Growth and Income funds generate some income. These funds buy stock in companies that have modest prospect for growth and pay good dividend yields.
Dividend Mutual Funds
Dividend mutual funds are another stock fund type that pay high dividends - which has advantages and disadvantages.
The upside is that you get dividends!
The downside is that the stocks the fund invests in don’t grow much which means their return through capital gains is lower - but they are almost guaranteed income through dividends.
Dividend funds are sought after by retired investors and those nearing retirement. Stocks that pay high dividends are usually strong companies that have been around for some time.
Imputation funds in some countries predominantly invest in companies that pay franked dividends (dividends which attract less tax), and offer potential for solid capital growth over the longer term.
Sector Mutual Funds
Sector funds invest in a specific industry (e.g., resources). These funds allow the small investor to invest in a highly select industry. The funds usually aim for growth.
Single-sector share funds include funds investing in only domestic shares or international shares. Some single sector types of mutual funds also specialize within a sector; for example, small-companies funds (or small cap mutual funds), international resources funds and geared stock funds.
Mutual funds for children provide a similar choice of fund types to single-sector funds and operate in a similar manner.
Differences only relate to the age of the investors, the low investment amounts and the tax treatment.
Bear Mutual Funds
Bear mutual funds, or short funds, come in two different forms. One is an actively managed fund and the other is an inverse-index fund that shorts entire indexes.
Both types of mutual funds in the 'bear' category are positioned to make money only when the market is going down, that is in bear markets. Bear funds are considered an aggressive approach to investing.
Another way of categorizing types of mutual funds is by the size of the companies they invest in, as measured by their market capitalization (market cap).
The three main categories include ...
- Small-cap mutual funds buy shares of small companies. The stock prices for these companies tend to be more volatile, and dividends may not always be present. You may also find funds called micro cap, which invest in the smallest of listed companies.
- Mid-cap mutual 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 mutual funds buy shares of big companies. The stock prices for these companies tend to be relatively stable (but don't think Enron), and the companies may pay a decent dividend.
I tend to mainly ignore these mutual-fund labels as they are somewhat artificial. However, they do provide some guide as to what you may be in for if you invest in one or more of them.Absolute Return Funds
A fund type that I do invest in that is not mentioned above is the absolute return fund. The managers of this type of fund see themselves as 'stock pickers' rather than 'index huggers'. They look for stocks that are undervalued and invest in them until they judge them to be over-valued.
Alternatively, they may short sell shares that appear over-valued with the aim to make money if and when their price drops to, or below, fair value.
So they tend to make more money in market down-turns than other funds who don't short sell.
Their aim is to maximize returns, irrespective of the sector, or the size of the company, or anything else that defines the various types of funds categorized above.
Their philosophy seems to encapsulate what I think value investing is all about - producing the best possible return irrespective of market conditions - or what the herd is up to.
So there is a wide variety of choice in the types of mutual funds or share fund types.
I try to choose funds that are not too big, as performance is difficult to maintain as size increases (unless they are global and the world is their oyster!).
And as I mentioned above, I prefer absolute return funds because of their focus on making money rather than trying to 'hug an index'.
I also keep an eye on management expense ratios (MERs) as small increases can have a significant effect on returns.
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