Types of funds

Most investment companies are funds, including mutual (open-end) funds, closed-end funds, and exchange-traded funds (ETFs). A fund’s “type” is based on its investment objective and the kinds of securities it holds. Some types are easy to recognize, while others tend to show up on exams as straight memorization.

These are the primary types to know:

• Growth funds
• Growth and income funds
• Balanced funds
• Income funds
• Specialized funds
• Sector funds
• Index funds
• Asset allocation funds
• International/global funds

Growth funds

A growth fund seeks capital appreciation (buy low, sell high). It typically invests in growth-focused common stocks. It may also hold convertible preferred stock and bonds because the ability to convert into common stock creates potential for capital gains.

Sidenote

Capitalization

Funds are sometimes classified by the size of the companies they invest in. Market capitalization is a common way to measure company size. You calculate it by multiplying a company’s outstanding common shares by the current market price per share. For example, a small-cap growth fund invests exclusively in smaller companies.

While the exam doesn’t heavily test every market-cap category, here are the five primary ones:

Mega-cap

• $200 billion or more

Large cap

• Between $10 billion - $200 billion

Mid-cap

• Between $2 billion - $10 billion

Small-cap

• Between $250 million - $2 billion

Micro-cap

• Less than $250 million

In general, smaller companies tend to have both higher risk and higher growth potential. When a small company performs well in a strong economy, it can grow quickly. On the other hand, smaller companies are often the first to fail when a recession occurs.

Definitions

Recession

General economic decline over six straight months (two quarters)

Keep this relationship in mind for test questions. Mega- and large-cap funds hold larger, well-established companies. They still carry risk, but they’re typically less aggressive and less volatile than small- or micro-cap growth funds.

Aggressive growth funds are still growth funds, but they take on more risk. They invest in common stock with higher return potential, often emphasizing small- and micro-cap stocks and companies in volatile or emerging industries.

Real world examples

• Fidelity Blue Chip Growth Fund (ticker: FBGRX)
• Clearbridge Aggressive Growth Fund (ticker: SHRAX)

Growth and income funds

Growth and income funds seek capital appreciation, but they also aim to generate income. They do this by investing in income-producing common and preferred stocks. Virtually all preferred stocks have a fixed dividend rate, but dividends on common stock are typically paid only by larger, well-established companies (e.g., Walmart, Coca-Cola, Procter & Gamble).

Dividend-paying stocks are generally less risky than growth-focused common stocks. To pay consistent dividends, a company usually needs consistent profits. Many growth companies are unprofitable or have volatile revenues, so they’re less likely to pay steady dividends. Because of that, a fund that allocates part of its portfolio to dividend-paying stocks is generally more conservative (less risky) than a pure growth fund.

Definitions

Conservative

Low risk

Aggressive

High risk

Real world example

• Vanguard Growth and Income Fund (ticker: VQNPX)

Equity income funds shift the emphasis further toward income. Their primary objective is current income from dividend-paying common stocks - typically large-cap, value-oriented companies - with capital appreciation as a secondary goal. This is the reverse priority of a growth and income fund, which pursues capital appreciation and income more evenly rather than putting dividend income first.

Balanced funds

Balanced funds are similar to growth and income funds, but they typically target a more even split between growth-oriented common stock and income-producing securities, including debt securities.

A key distinction:

• Balanced funds invest in stocks and bonds.
• Growth and income funds invest in stocks only.

Don’t mix these up.

Real world example

• Schwab Balanced Fund (ticker: SWOBX)

Income funds

Income funds invest only in income-producing securities, so they’re generally more conservative and less risky than growth-focused funds. A major reason is that common stock prices can be highly volatile, moving with business activity and overall economic conditions. If a company has a poor year or the economy enters a recession, common stock investors can experience significant losses.

Income funds commonly hold bonds, preferred stocks, and dividend-paying common stocks.

• Bond issuers are legally required to pay interest.
• Bond prices typically experience major swings when interest rate or inflation risk is high.
• Preferred stock dividends aren’t legal obligations, but issuers usually skip them only when facing serious financial trouble.
• As noted earlier, the largest and most established companies are the most likely to pay dividends on common stock.

Because of these factors, a diversified portfolio of income-producing investments can often reduce the chance of significant losses (though not in every market environment).

Different types of income funds include corporate bond funds, municipal bond funds, and US Government bond funds, which invest in the securities of those issuer types. There are also high yield bond funds, which invest in riskier “junk” bonds with higher yields. Conversely, conservative bond funds invest in investment-grade bonds with lower risk and lower yield. International bond funds invest in bonds issued by foreign companies and governments.

Investors can also find Ginnie Mae, Fannie Mae, and Freddie Mac funds, which invest in the mortgage-backed securities of these federal agencies. Fannie Mae and Freddie Mac purchase mortgages from financial institutions, while Ginnie Mae doesn’t purchase mortgages at all - it guarantees qualifying mortgage-backed securities issued by approved private lenders. Either way, investors receive income from the interest and principal payments made on the underlying mortgages. Although these funds are 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.

Money market funds are also a type of income fund, but they generally pay small amounts of income. As a reminder, money markets are fixed-income securities with one year or less to maturity. Many investors use money market funds similarly to bank savings accounts. When an investor holds cash in a brokerage account, it’s typically invested in a money market fund.

Money market funds are:

• Priced at a consistent $1.00 per share
• Typically pay dividends monthly

Investors can reinvest dividends to buy additional $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.

Real world examples

• JP Morgan Corporate Bond Fund (ticker: CBRAX)
• American High-Income Municipal Bond Fund (ticker: AMHIX)
• Dreyfus US Treasury Long-Term Fund (ticker: DRGBX)
• PGIM High Yield Fund (ticker: PBHAX)
• Fidelity Conservative Income Bond Fund (ticker: FCNVX)
• Vanguard GNMA Fund (ticker: VFIIX)
• T. Rowe Price Cash Reserves Fund (ticker: TSCXX)

Specialized funds

Specialized funds aren’t defined by “growth” or “income.” Instead, they invest only in securities from a specific industry or region, so their risk and return potential can vary widely. Funds that focus on particular industries are sometimes called sector funds.

Real world examples

• RMB Japan Fund (ticker: RMBPX)
• Columbia Seligman Technology and Information Fund (ticker: SLMCX)
• Schwab Health Care Fund (ticker: SWHFX)
• T. Rowe Price European Stock Fund (ticker: PRESX)

Index funds

Index funds aim to match the return 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 common example is the S&P 500, which is often used as shorthand for “the market.” The S&P 500 is a list of 500 large company stocks traded in the United States. Investors use indexes to gauge broad market trends. When the S&P 500 is up, it’s often interpreted as the overall market moving upward.

Indexes come in many forms:

• Small- and large-cap indexes (tracking smaller vs. larger companies)
• Bond indexes (tracking bond values across issuer types)
• Specialized indexes (tracking specific industries or regions)

Investing styles are often grouped into two categories:

• Active management: selecting what the manager believes are the best investments within a market. For example, the manager of the Fidelity Large-Cap Stock Fund (ticker: FLCSX) chooses what they consider the best large-cap stocks.
• Passive management: tracking an index as closely as possible. For example, the manager of the Fidelity 500 Index Fund (ticker: FXAIX) invests in the same stocks as the S&P 500.

With index funds, there’s no “picking and choosing” securities; the portfolio is built to mirror the index.

Passive management through vehicles like index funds is becoming very popular in the market, now accounting for more than half of the US equity market cap. We’ll discuss more about this investing style later in this unit.

Real world examples

• iShares Total U.S. Stock Market Index Fund (ticker: BASMX)
• Shelton NASDAQ-100 Index Fund (ticker: NASDX)
• Northern Bond Index Fund (ticker: NOBOX)

Asset allocation funds

Asset allocation funds invest across asset classes in set proportions or in proportions that change over time.

Some asset allocation funds maintain a constant mix. For example, Fidelity’s Asset Manager 70% Fund invests 70% of its assets in stocks, with the remaining 30% invested in long- and short-term debt securities.

Other asset allocation funds shift their mix based on expected market performance or fund requirements. Life cycle funds, also called target date funds, are designed to adjust over an investor’s lifetime. They typically start out more aggressive (heavier in growth stocks) and become more conservative over time by shifting into fixed-income securities. This structure reflects a common planning idea: as an investor gets older, they generally take on less risk.

A common example is the Vanguard Target Retirement 2050 Fund, which was created for investors targeting retirement around 2050. The fund is aggressive today, with roughly 90% of assets in stocks, and it gradually shifts more toward bonds and other fixed-income securities over time.

Real world examples:

• Spectrum Conservative Allocation Fund (ticker: PRSIX)
• Franklin LifeSmart 2050 Retirement Target Fund (ticker: FLSOX)

International/global funds

As the names suggest, international and global funds invest outside the United States.

• International funds invest only in securities issued outside the US.
• Global funds invest worldwide, including US-based securities.

These funds can add diversification and may help hedge against domestic risks.

Real world examples:

• Causeway International Value Fund (ticker: CIVIX)
• Kopernik Global All-Cap Fund (ticker: KGGAX)