A look at mutual fund categories
Key Points
- Categories for Different Needs
- Choose Funds That Match Your Goals
- Watch Your Basket
- Evaluating Mutual Fund Performance
- Points to remember
With more than 8,700 mutual funds available today, according to a 2007 Investment Company Institute report, selecting the most suitable ones for your portfolio is a tricky business. Overwhelmed by the sheer number of funds, new investors understandably may be confused. People invest in mutual funds mainly because they don't have time to examine thousands of individual securities, yet selecting specific mutual funds isn't any easier.
True, picking the right funds will take some time. But once you have some understanding of the different fund categories - which determine the kinds of securities that fund managers select for their funds - the industry's messy and seemingly endless differentiation will clarify itself. You can then devise a mutual fund investment strategy that will work for you, bearing in mind your time horizon and ability to withstand fluctuations in the value of your portfolio.
Categories for Different Needs
Despite the fund industry's endless differentiation, equity mutual funds boil down to five large groups: aggressive growth funds, growth funds, growth and income funds, balanced funds, and sector funds. Besides those, there are also categories of bond funds, money market funds, and global and international funds.
- Aggressive growth and small-cap funds are among the most aggressive equity funds. Aimed at maximizing capital gains, these funds invest in companies with the potential for rapid growth (companies in developing industries, small but fast-moving companies, or companies that have fallen on hard times but appear due for a turnaround). Some aggressive growth funds use several investment strategies - which may include options and futures - in an effort to achieve superior returns. These funds can be very volatile in the short term, but in the long run they may offer the potential for above-average capital appreciation. Aggressive growth funds are generally more suitable for long-term investors with a time horizon of 10 years or longer.
- Growth funds also strive for capital appreciation by investing in companies that are positioned for strong earnings growth. Funds in this group vary widely in the amount of risk they take. But in general, they are less risky than aggressive growth funds because they normally invest in well-established companies. Growth funds may entail less volatility than aggressive growth funds, but also less potential for capital appreciation. Neither aggressive growth funds nor growth funds strive for dividend income. In fact, the companies they invest in often do not pay dividends to their shareholders, but reinvest the earnings to fuel future growth.
- Growth and income funds strive for both dividend income and capital appreciation by investing in companies with solid records of dividend payments and capital gains. Some growth and income funds emphasize growth while others emphasize income. Growth and income funds may be less risky and less volatile than pure growth funds but may also offer less potential for capital appreciation.
- Balanced funds offer one-stop shopping by combining stocks and bonds in a single portfolio. Balanced funds are more conservative than the previously discussed categories and usually invest in blue-chip stocks and high-quality taxable bonds. They may potentially hold up better in rough markets, because when their stock investments fall, their bonds may do well, and vice versa. Because they offer diversification, balanced funds are often suitable for people with a small amount of cash to invest.
- Sector funds concentrate on one industry (such as technology, financial services, or consumer goods) or focus on certain commodities (such as gold, gas, or oil). Selected by more experienced investors who are willing to pay close attention to the market, sector funds are less diversified than the broader market and hence are often more volatile.
- Bond funds can be divided into four broad categories: tax exempt, taxable, high quality, and high yield. Within these categories, funds are also segmented by maturities, type of issuer, and credit quality of bonds in which they invest. Tax-exempt bond funds buy bonds issued by state and municipal agencies, while taxable bond funds may invest in all other debt securities. High-quality bond funds stick with government and top-rated corporate or municipal bonds that offer relatively lower interest. High-yield bond funds buy lower-rated or non-investment grade corporate or municipal bonds, or "junk bonds," which offer higher interest to compensate for the higher risks that investors take. While bond funds in general are less risky than stock funds, the return on principal is not guaranteed and bond funds have the same interest rate, inflation, and credit risks that are associated with the underlying bonds owned by the fund.
- Money market funds invest in short-term money market instruments, such as U.S. Treasury bills, commercial paper, certificates of deposit, and repurchase agreements. Striving to maintain a stable share price of $1, money market funds offer maximum safety and liquidity, as well as a yield that's generally higher than that of bank deposits, which unlike money market funds, are FDIC-insured.1
- Global and international funds can help diversify your assets into a wide array of foreign stocks and bonds. The difference between the two groups is that global funds may buy a mix of U.S. and foreign stocks, whereas international funds invest exclusively overseas. Under the two fund groups, there are regional funds and country funds designed to take advantage of specific investment opportunities in the world's developed and emerging countries. In terms of risk ratio, global and international funds vary widely from lower-risk funds that invest in established markets to higher-risk emerging market funds. Be aware that international securities may face additional risks, such as higher taxation, less liquidity, political problems, and currency fluctuations, that do not affect domestic securities.
- Asset allocation funds may be another option for investors looking to simplify their choices. They generally invest in a mix of stocks, bonds, and money markets based on a particular time horizon. For example, there may be a fund targeted to investors with a 20-year goal and one for investors with a 30-year goal.
Choose Funds That Match Your Goals
| Equities | Fixed Income |
|---|---|
|
Watch Your Basket
The adage "Don't put all your eggs in one basket" applies to mutual funds as much as any other type of investment. By investing in only one fund category, you may subject your assets to an undue amount of risk. One way to help minimize risk is to practice diversification, or spreading your assets among a variety of funds within different categories.2
Evaluating Mutual Fund Performance
| 1 Year | 3 Years | 5 Years | 10 Years | |
|---|---|---|---|---|
| Large-Cap Growth | -40.67% | -10.28% | -3.37% | -2.46% |
| Mid-Cap Growth | -43.77% | -10.92% | -2.44% | 0.79% |
| Small-Cap Growth | -41.55% | -11.35% | -3.52% | 1.51% |
| Large-Cap Value | -37.09% | -8.92% | -1.79% | 0.90% |
| Mid-Cap Value | -36.77% | -9.93% | -1.07% | 5.23% |
| Small-Cap Value | -32.24% | -9.63% | -0.97% | 5.51% |
| Taxable Fixed Income (Long) | -3.72% | 0.38% | 1.48% | 3.94% |
| Taxable Fixed Income (Short) | -4.23% | 0.96% | 1.23% | 3.38% |
| Money Market | 2.00% | 3.67% | 2.87% | 3.04% |
| Foreign (Developed) | -43.99% | -7.67% | 1.21% | 0.90% |
| Emerging Market | -54.44% | -6.38% | 6.13% | 8.74% |
This table shows the performance achieved by various mutual fund categories over the past 1-, 3-, 5-, and 10-year time periods ended December 31, 2008.
Source: Morningstar. Based on the average total returns of all funds tracked by Morningstar within a category. Performance shown is for illustrative purposes only and is not indicative of the performance of any specific investment. Past performance does not guarantee future results. Does not take taxes, brokerage fees, or sales charged into account.
Understanding mutual fund categories is only the first step in mutual fund investing. The next step is to match your goals, time frame, and risk tolerance to appropriate fund categories.
Points to Remember
- Mutual fund categories determine the types of securities that mutual fund managers select for their funds.
- Some equity fund categories are aggressive growth, growth, growth and income, balanced, sector, global, and international.
- Bond funds include taxable and tax-exempt funds and are also segmented by maturity, issuer, and credit quality.
- Investors should match their objectives to a particular category but be cautious about focusing too heavily in any one area.
- Diversifying among funds is one way to help minimize risk in your portfolio.
1 An investment in a Money Market Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.
2 Diversification helps you spread risk throughout your portfolio, so that investments that do poorly may be balanced by others that do relatively better. Diversification does not ensure a profit or protect against loss.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
You should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. For a free prospectus, which contains this and other important information about the funds, contact your financial advisor or visit ameriprise.com. Read the prospectus carefully before investing.
There are risks associated with an investment in a bond fund, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities.
Investments in small- and mid-capitalization companies often involve greater risks and potential volatility than investments in larger, more established companies.
International investing involves increased risk and volatility due to potential political and economic instability, currency fluctuations, and differences in financial reporting and accounting standards and oversight. Risks are particularly significant in emerging markets.
Investments in a narrowly focused sector such as real estate may exhibit higher volatility than investments with broader objectives. An investment in real estate is subject to market risk, economic risk, and mortgage rate risk.
Investments, brokerage and investment advisory services offered through Ameriprise Financial Services, Inc., Member FINRA and SIPC.