There is a sizeable selection of mutual funds to choose from. This is one of their advantages. Remember that each fund represents a basket of investments composed of different securities or assets. A particular mutual fund is categorized or classified according to its composition or its principal investment. This means that mutual funds are classified according to their underlying investments or the securities and assets they are invested in. Others are also classified according to the general investment principle on which they were based. Some are labeled according to focused industries or markets. It is important for investors to understand these different types of mutual funds first to ensure that their choice is aligned with their personal investment goals and objectives, risk appetite, and investment time horizon.
Understanding the Different Types of Mutual Funds and Choosing the Most Suitable One Based on Personal Investment Profile
1. Types By Underlying Investments
It is important to reiterate the fact that mutual funds are one of the common types of pooled funds in which monies from different investors are pooled together to invest in a diversified portfolio of securities and assets like equities or stocks, debentures or bonds, cash equivalents, and derivatives, among others. The composition of a particular fund serves as the general basis for its classification: The following are the types of mutual funds based on the underlying investments:
• Equity Funds: These funds are invested in stocks of companies. They can be categorized further based on the market capitalization of companies. These include small-cap, mid-cap, or large-cap funds. Some are categorized according to industry or sector. Examples include technology funds or artificial intelligence funds. Investing in equity funds carries the same risks as purchasing individual stocks but also offers the highest potential for returns. This means that they are more suitable for investors with longer time horizons and have an aggressive risk profile.
• Bond Funds: Another type of mutual fund represents funds that invest in fixed-income securities. These are called bond funds. The specific composition of these funds includes government bonds like Treasury Bills and different types of corporate bonds like investment-grade bonds and high-yield bonds. Bond funds are considered safer investments or less riskier than equity funds. They are also less volatile. The downside is that they generally have lower performance. These make them ideal for investors with moderate to conservative risk profiles. Investing in these funds is also ideal for individuals seeking wealth preservation.
• Money Market Funds: These funds are somewhat similar to bond funds but are focused on investing in short-term debt instruments. Specific examples include certificates of deposits, Treasury Bills, and commercial papers. They are also considered a safer investment. Most money market funds are even less volatile than bond funds. However, because of their lower potential for generating returns, they are suitable for conservative investors who want to keep their capital intact for wealth preservation purposes or for building generational wealth.
• Balanced Funds: Another type of mutual funds invests in both equities and bonds. These are called balanced funds or hybrid funds. They are called as such because they attempt to reap the benefits of investing in both stocks and bonds. In other words, because they are invested in both equities and bonds, they attempt to balance both growth objectives and capital preservation. These funds are ideal for investors with moderate risk profiles and are seeking to have considerable returns by managing the higher risks from stock investing through bond investing.
• Specialty Funds: These funds are based on a central investment objective of either maximum investment exposure, alternative investment options, or narrow-focused exposure. They are invested in derivatives like options and future contracts, commodities like precious metals and oil, and specific stocks or bonds from sector-specific companies. The performance of these funds varies and is dependent on their principal investment objective. The consensus is that they have higher potential returns at higher risks because of their specialized composition.
2. Types By Fund Management Style
It is important to note that there are two different approaches to managing pooled funds like mutual funds. These are active management and passive management. The former adheres to the principles of active investing while the latter follows the principles of passive investing. Below are the types of mutual funds based on management style:
• Actively Managed Funds: These funds are based on an investment approach that involves hands-on management by fund managers. Active managing means that the fund managers regularly research companies, select investments, and make buying and selling or trading decisions to outperform a benchmark like a stock market index. The composition of the funds changes. This means that they can provide a higher return potential at an increased risk. This makes them suitable for aggressive investors. Another downside is that they have the highest costs or fees.
• Passively Managed Funds: These funds have lower costs or fees than actively managed funds. This comes from the fact that they are not actively managed or changed and that their composition tends to remain stagnant for longer periods. The objective of these funds is not to outperform a particular benchmark but to replicate its performance. Most of these funds mirror the composition of the benchmark or index that they intend to replicate. The performance still varies but is generally average. Their suitability also depends on their underlying investments.
3. Types By Investment Strategies
Several companies that offer mutual funds have also categorized their product offerings based on the foundational investment strategies used. There are funds that are geared toward following the principles of growth investing while others are focused on the principles of value investing. Others are focused on a defensive investment strategy. There are also funds that are based on a predefined time horizon. Others are focused on either following a benchmark or index or generating regular income. Take note of the following:
• Growth Funds: These funds are focused on growth investing. The objective is to outperform benchmarks or stock indices. Most of these funds are composed of growth stocks or stocks with the potential for substantial long-term growth. These can include small-cap and large-cap stocks. Some are also invested in high-yield bonds and other high-return exchange-traded funds. Growth funds depend on capital appreciation rather than income generation. This makes them suitable for moderate to aggressive investors with long-term investment horizons.
• Value Funds: Another type of mutual funds is based on value investing. Fund managers pick value stocks or stocks of companies that appear undervalued but have higher true intrinsic value as determined by fundamental analysis. The objective of these funds is to generate substantial capital appreciation over a long-term period. Furthermore, aligned with the principles of value investing, these funds remain true to the buy-and-hold investment paradigm while still being actively managed to avoid losses and generate adequate investment returns.
• Defensive Funds: Take note that a defensive investment strategy prioritizes protection first and growth second. It also aims to minimize losses during a market or greater economic downturn. These are the key objectives of defensive funds. These funds invest in defensive stocks and other defensive securities and assets like high-quality bonds, cash and cash equivalents, productive real estate, and precious metals. Investing in these funds is ideal for conservative investors seeking capital or wealth preservation for long-term holding or as part of their legacy planning.
• Income Funds: A particular income fund is one of the examples of income-generating assets or investments. This type of mutual fund focuses on generating income as soon as possible rather than long-term and substantial capital appreciation. It is important to note that income funds provide their investors with a steady stream of income. Hence, to generate income, they are invested in divided stocks or preferred stocks, and fixed-income securities. This makes them ideal for retirees seeking a productive use of their savings while keeping it intact or preserved.
• Index Funds: There is a subset of equity funds that are invested in companies included in a stock index or stock indices. It is called an index fund. The central investment objective of this fund is to mirror the performance of a particular index like the S&P 500 rather than outperforming it. This means that it is passively managed and might be less risky than actively managed equity funds. It still shares the risks inherent to stock investing. This makes them suitable for moderate to aggressive investors seeking substantial gains within a longer investment time horizon.
• Target-Date Funds: A target-date fund or age-based fund is designed as a simplified and one-stop retirement investment solution. This fund holds a mix of securities and assets. The entire composition and general investment objective shift over time based on the age of the investor. The fund starts to lean toward moderate to conservative investing as the investor approaches his or her target date or retirement age. This happens through allocation shifts that would reduce investments in aggressive securities or assets like stocks until the fund becomes fully conservative.
Important Pointers on the Different Types of Mutual Funds and Selecting the Most Suitable One Based on Personal Investment Profile
Remember that the selection of funds or the different types of mutual funds provides interested investors with advantages. The presence of options allows them to streamline their investment decision by choosing a single fund or a couple of funds and transactions instead of researching and selecting individual securities or assets. Each type of fund has its investment goals and objectives, risk level, and recommended investment time horizon. The following is a snapshot of general investor risk profiles and investment objectives and the suitable types of mutual funds for them:
• Aggressive Investors: These investors are suitable for equity funds or a specific subset of equity funds like growth funds. They are also suitable for sector-specific balanced funds that are invested in tech companies. Specialty funds focusing on high-return securities and assets are also ideal for them. Remember that aggressive investors can tolerate market volatility or movements in the prices of securities or assets and thus, period losses and gains in capital because of their longer investment time horizon.
• Moderate Investors: Several types of mutual funds are suitable for moderate investors. These include index funds, for those who want to still invest in stocks, bond funds with allocations in high-yield funds, money market funds, and balanced funds. The characteristics of moderate investors can differ. Some may lean toward a near-aggressive profile while others may be inclined toward a near-conservative profile. Those in the middle ground are better suited for index funds and balanced funds.
• Conservative Investors: These investors seek capital or wealth preservation. They cannot tolerate risks because they have a shorter investment time horizon, need to access their investments as soon as possible or within five to ten years, or want to pass their investments or assets once they passed. They are suitable for bond funds, money market funds, and defensive funds. Some income funds with allocations in bonds or fixed-income securities are also suitable for income-seeking conservative investors.
Take note that the aforementioned snapshot is not absolute. An investor needs to define his or her investment goals and objectives or determine the reasons behind his or her decision to invest. This typically requires answering a set of suitability assessment questionnaires or an interview with a financial or investment advisor. The rule of thumb is that all investments have risks. The level of risk varies. An individual must ensure that his or her risk profile, investment goals and objectives, and time horizon are aligned with the characteristics of a particular type of mutual fund.
