/Lydia Wanjiru/ -- A mutual fund pools money from a variety of investors to create a portfolio of stocks, bonds, real estate, money market instruments or other securities. Some mutual funds concentrate on a single asset class such as stocks or bonds while others invest in a variety. Mutual funds are bought directly from the fund companies such as Vanguard, T. Rowe Price or Fidelity and more, unlike stock market where shares can be bought from one investor to another. A professional manager for the fund invests the money in different types of assets including stocks, bonds, commodities and other assets. Investors earn from the mutual funds through dividends on stocks and interest on bonds. You can invest in mutual funds with as low as $100 but the majority of mutual funds require a minimum initial investment of between $500 to $3000 and the institutional class funds and hedge funds require at least $1million or more. Mutual funds trade once per day, unlike ETFs. There are 10 common types of mutual fund investments which include:
1. Money Market Funds
Money market funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are risk-free or the risk involved is relatively low and the potential returns are equally low. Investing in money market funds guarantees that you don’t lose your principal amount and you get a return that is relatively higher than you would get in a regular checking or savings account but a little less than the average certificate of deposit (CD). It can, however, experience loss like in 2008 financial crisis where it broke the buck.
2. Fixed income funds
Fixed income funds invest in a fixed rate of return investments such as the government bonds, investment-grade corporate bonds, and high yield corporate bonds. The aim of these funds is to have a regular income mostly achieved through interest that the fund earns. The high-yield corporate bond funds have a potentially higher income and risk compared to funds that hold government and investment-grade bonds. Most investors of these funds are conservative investors and retirees because they provide a steady cash flow to investors.
3. Bond funds
Bond funds invest in various types of bonds and aim at buying relatively undervalued bonds in order to sell later at a profit. They are likely to pay higher returns compared to certificates of deposit and money market investments but also with a higher risk.
4. Equity funds
Equity funds invest in stocks and aim at growing faster than money market or the fixed income funds. The risk is higher and the potential return is equally higher. You can choose from a wide range of equity funds such as those that specialize in growth stocks and usually don’t pay dividends, income funds that pay large dividends, value stocks, large-cap stocks, mid-cap stocks, small-cap stocks or a combination of any or all of them. These funds classify funds based on the size of the company and the growth prospects of the invested stocks.
5. Balanced funds
Balanced funds invest in a combination of equities and fixed income securities and aim at balancing the idea of achieving higher returns against the risk of losing money. They have a higher risk than the fixed income funds but lower than pure equity funds. The conservative funds hold fewer equities relative to bonds while the aggressive funds hold more equities and fewer bonds.
6. Index funds
Index funds aim at tracking the performance of a specific index, for example, the S&P 500 index or Dow Jones Industrial Average (DJIA) Index. The value of the mutual fund moves up and down as the index goes up and down. These funds have lower costs than the actively managed funds because the portfolio manager doesn’t have to analyze it much compared to other funds.
7. Specialty funds
Specialty funds have a special focus such as the commodities, real estate or socially responsible investing or ethical funds that invest in companies that support environmental stewardship, diversity, human rights and more. These funds don’t invest in industries that are “unethical” like tobacco, alcohol, weapons and more. Sector funds target specific sectors of the economy such as financial, technology healthy and more.
8. Funds of funds
Fund-of-funds invest in other funds and aim at balancing asset allocation and diversification to make it easier for the investor.
9. Exchange Traded Funds (EFTs)
These are investment funds that pool investors similar to mutual funds but they are structured as investment trusts that are traded on stock exchanges. ETFs are bought and sold any time throughout the trading day and can be short sold or bought on margin. They have lower fees and tax advantages than mutual funds and investors can hedge their positions
10. Global/international funds
These funds invest only in assets that are located outside your home country anywhere across the world. These funds are more volatile and are exposed to the specific country and political risks. They aim at diversifying your investment portfolio because the returns in foreign countries are uncorrelated with returns from your home country.