Types of funds

Most investment companies are funds, including mutual (open-end) funds, closed-end funds, and exchange-traded funds (ETFs). The “fund type” depends on the fund’s investment goals and the securities it invests in. Some can be easily distinguished, while others may require 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 to attain capital appreciation (buy low, sell high), often by investing in growth-focused common stocks. Convertible preferred stock and bonds may also be included as their convertibility into common stock provides the potential for capital gains.

Aggressive growth funds are also growth funds, but with more risk involved. This type of fund invests in common stock that provides a higher return potential, including small and micro-cap (smaller) stocks from volatile or emerging industries.

Real world examples

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

Growth and income funds

Growth and income funds also focus on attaining capital appreciation, but also invest in income-producing common and preferred stocks. Virtually all preferred stocks maintain a fixed dividend rate, but only larger and well-established companies (e.g., Walmart, Coca-Cola, Procter & Gamble) pay dividends on their common stock.

Stocks that provide dividend income are generally less risky than growth-focused common stocks. To pay consistent dividends, a company must make consistent profits. Remember, most growth stock issuers are either unprofitable or have volatile revenues. These issuers would be unlikely to pay consistent dividends. Therefore, a fund allocating a portion of its portfolio to dividend-paying stocks is generally more conservative (less risky) than pure growth funds.

Real world example

• Vanguard Growth and Income Fund (ticker: VQNPX)

Balanced funds

Balanced funds are similar to growth and income, but this fund type seeks a relatively even distribution between growth-focused common stock and income-producing securities, which include debt securities. Balanced funds invest in bonds and stock, whereas growth and income funds only invest in stock. Don’t get the two mixed up!

Real world example

• Schwab Balanced Fund (ticker: SWOBX)

Income funds

Income funds only invest in income-producing securities and are generally more conservative and less risky than growth-focused funds. This is primarily due to price volatility in the stock market, which moves in various directions depending on business activity and general economic conditions. If a company has a rough year or the economy is going through a recession, common stock investors can experience significant losses.

Bonds, preferred stocks, and dividend-paying common stocks are the primary investments held in income funds. Bond issuers are legally required to pay interest, and the bond market typically only experiences significant price fluctuations when high levels of interest rate or inflation risk exist. Although dividend payments from preferred stock are not legal obligations, issuers generally only skip dividend payments if the company is facing remarkable financial troubles. As we discussed above, the largest and most well-established companies are the most likely to pay dividends on outstanding common stock. Due to these reasons, investors can usually avoid significant losses with a diversified portfolio of income-producing investments (although this is only sometimes true).

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 sizeable yields. Conversely, there are conservative bond funds that invest in investment-grade bonds with lower levels of risk and yield. International bond funds invest in bonds from foreign companies and governments.

Investors can also find Ginnie Mae, Fannie Mae, and Freddie Mac funds. If you recall, these are the federal agencies that purchase mortgages from financial institutions. Investors receive income originating from interest and principal mortgage payments. 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.

Money market funds are also a type of income fund, but generally pay small amounts of income. As a reminder, money markets are fixed income securities with one year or less to maturity. Many investors utilize money market funds similarly to their bank savings accounts. When an investor maintains cash in a brokerage account, it is typically invested in a money market fund. Priced at a consistent $1.00 per share, money market funds usually make monthly dividend payments. Investors can reinvest the dividends and 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. Additionally, sales charges (discussed later in this unit) and other transaction fees are rarely imposed on this type of fund.

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 are not specific to growth or income investments. These funds only invest in securities from a specific industry or region and can vary in risk and return potential. Funds that invest in 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 give their investors the same return as a specific index. An index is simply a list of securities that tracks and averages all of the values of the securities on that list. You’ve probably heard of the S&P 500, the most popular index that is commonly referred to as “the market.” The S&P 500 is a list of 500 large company stocks traded in the United States. Investors commonly use indexes to determine general trends in the market. When the S&P 500 is up, it is assumed the broad market is moving upward.

Indexes come in all shapes and sizes. There are small and large-cap indexes, which track stocks of smaller and larger companies, respectively. Also, there are a variety of bond indexes that track the bond values of various issuers. Additionally, specialized indexes track investments from specific industries and regions.

Investing styles can be broken down into two general categories. Active management involves picking and choosing the best investments within a market. For example, the fund manager of the Fidelity Large-Cap Stock Fund (ticker: FLCSX) identifies and invests in what they consider the best large-cap stocks in the market. On the other hand, passive management involves tracking an index as closely as possible. The fund manager of the Fidelity 500 Index Fund (ticker: FXAIX) invests in the same stocks in the S&P 500. There is no “picking and choosing” investments with index funds; asset managers simply copy the index.

Passive management through vehicles like index funds is becoming very popular in the market. 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 in specific asset classes depending on various factors. Some asset allocation funds maintain a constant asset mix, like the Fidelity’s Asset Manager 70% Fund, which invests 70% of portfolio assets in stocks, with the remaining 30% invested in long and short term debt securities.

Some asset allocation funds shift their structures around due to expected market performance or fund requirements. Life cycle funds, also known as target date funds, maintain changing allocations and are meant to “follow along” an investor’s lifetime. They start more aggressively when originally issued, investing primarily in growth stocks. As time passes, the fund becomes more conservative by shifting assets into safer fixed-income securities. This structure enforces good investment practices; the older an investor is, the less risk they should expose themselves to. A good example is the Vanguard Target Retirement 2050 Fund, which was created for investors targeting retirement around the year 2050. The fund is aggressive right now, with roughly 90% of the assets invested in stocks, but the allocation will shift more to bonds and other fixed income securities as time passes.

Real world examples:

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

International/global funds

As the name suggests, international and global funds seek investments outside the United States. International funds only invest in securities issued outside the US, while global funds invest worldwide, including in US-based securities. Investments in these funds provide an added layer of diversification and can hedge an investor against domestic risks.

Real world examples:

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