There are a wide variety of different types of mutual funds which are pools of stocks and/or bonds that are professionally managed. Typically, a sponsor company will pay a portfolio manager to buy groups of securities based upon a specific investment strategy. Generally, mutual funds can be classified within four basic categories: money market funds, bond funds, hybrid funds and stock (or equity) funds.
Money market funds are generally referred to as short term funds because they invest in securities that mature in one year or less and are considered very liquid. These funds are more appropriate for investors seeking preservation of capital and a relatively stable share price. These are an excellent choice for your short term investment goals. These funds are neither insured nor guaranteed by the FDIC or any government agency. Although money market funds seek to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in a fund.
Bond funds typically offer higher yields than money market funds, but investors must accept a higher level of risk.
Hybrid funds, which can also be known as balanced funds or asset allocation funds, invest in a mix of equities, bonds and money market securities.
Stock (or equity) funds typically involve more risk than money market, bond funds or hybrid funds because they invest primarily in the stocks of companies. Within the classification of stock funds, you will find even more specific classifications, which include growth or value funds, in addition to international, sector-based and index funds.
It is important that your fund selection fits within your existing asset allocation model. If you are already heavily invested in bonds, for example, you may not want to consider bonds if you are looking for further diversification.
The costs of investing in mutual funds have received an increasing amount of attention. Knowing all direct and indirect expenses is essential in evaluating your investment choices. The costs paid by the funds and their shareholders are listed in the mutual fund prospectus in the section called “Fees and Expenses.” There are two categories: Shareholder Fees, which are paid directly from an investment and typically include sales charges, purchase and redemption fees, account fees and Annual Fund Operating Expenses, which are deducted from the fund’s assets. Investment management fees typically represent the most significant part of operating expenses. These fees vary significantly depending on the type of funds.