We’ve already covered the basic characteristics of mutual funds, closed-end funds, and exchange-traded funds (ETFs). Now the focus shifts to common fund types, which are usually defined by:
Some fund types are easy to tell apart, while others are easy to confuse. Working through the common categories helps you understand the choices investors have - and helps with suitability questions.
A growth fund seeks capital appreciation - in other words, it aims to increase the value of the investment over time.
Growth funds most often invest in common stock because it offers the greatest potential for capital gains. They may also include:
These securities can be converted into common stock, which gives them additional capital appreciation potential.
Aggressive growth funds are growth funds with a higher risk profile. They invest in common stock with higher return potential, often including:
Stock of small-cap companies
Companies in volatile or emerging industries
Growth and income funds, sometimes called blend funds, seek capital appreciation but also invest in income-producing stocks. These funds typically invest in:
Dividend-paying stocks are generally less risky than pure growth stocks because consistent dividends usually require consistent profits. As a result, growth and income funds are typically more conservative than pure growth funds.
Balanced funds are similar to growth and income funds, but they aim for a more even mix between growth and income investments.
A key distinction:
It’s easy to mix these up, so keep the stock-and-bond feature tied to balanced funds.
Income funds focus on producing current income, not capital appreciation. They invest in income-producing securities such as:
Because they emphasize income and typically hold less volatile securities, income funds are generally more conservative and less risky than growth funds.
Why are growth funds usually riskier than income funds? The main reason is price volatility in the stock market. Stock prices can move sharply based on business performance and economic conditions. If a company has a poor year - or the economy enters a recession - common stock prices can fall significantly.
Income-oriented investments tend to be more stable:
Different types of income funds include corporate bond funds, municipal bond funds, and US Government bond funds, which invest in those issuer categories. There are also:
Investors can also find Ginnie Mae, Fannie Mae, and Freddie Mac funds. These agencies purchase mortgages from banks to make it easier for Americans to purchase real estate. Investors receive income that originates from interest paid on mortgages. Although subject to prepayment and extension risk, Ginnie Mae, Fannie Mae, and Freddie Mac funds are suitable for risk-averse investors seeking conservative investments due to the government backing of agency securities.
Asset allocation funds invest across asset classes (such as stocks and bonds) based on a chosen allocation strategy. For example, an asset allocation fund might hold a:
Some asset allocation funds keep a relatively constant mix, such as Fidelity’s Asset Manager 70% Fund, which invests 70% of portfolio assets in stocks and the remaining 30% in long- and short-term debt securities.
Other asset allocation funds change their mix based on market expectations or fund rules. Life cycle funds, also called target date funds, are designed to adjust over time to match an investor’s expected timeline. They typically:
A common rationale is that as an investor gets older, they generally take on less risk. For example, the Fidelity Freedom 2050 Fund targets investors planning to retire around 2050. The fund is currently aggressive, with over 90% of assets invested in stocks, but it will shift more toward bonds and other fixed-income securities over time.
Money market funds are a type of income fund, but they generally pay small amounts of income. Money market securities are short-term debt instruments with one year or less to maturity. Money market funds are typically low-risk and low-yield.
Many investors use money market funds similarly to a bank savings account. When cash sits in an investment account, it’s often placed in a money market fund. Priced at a consistent $1.00 per share, money market funds typically make monthly dividend payments. The investor can reinvest the proceeds to buy more $1.00 shares or take the payment as cash.
These funds are very liquid (easy to sell), provide a small amount of income, and are suitable for investors with short-term time horizons.
Specialized funds focus on a particular industry or geographic region rather than fitting neatly into “growth” or “income.” Examples include Japan funds, biotechnology funds, and Latin American funds. Risk and return potential vary widely depending on the region or industry.
Funds that invest in a specific industry are often called sector funds.
Index funds aim to match the performance of a specific index.
An index is a list of securities designed to track and average the values of the securities on that list. A well-known example is the S&P 500, which is commonly referred to as “the market.” The S&P 500 is a list of 500 large companies that are traded in the United States. Investors often use indexes to gauge broad market trends. When the S&P 500 is up, it’s commonly taken as a sign that the overall market is rising.
Indexes cover many different segments:
When investors buy an index fund, the fund isn’t trying to pick the “best” securities. Instead, it tries to match the index’s return as closely as possible. This approach is called passive investing, and it has becoming very popular in the market.
In this section, we covered the most common fund types in finance. These categories matter on the Series 66 exam, especially for suitability. You’ll see these fund types again in later sections.
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