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What types of mutual funds are available?
Although it may seem confusing, the types of mutual funds provided are separated by what their focus.  For example, a mutual fund called "a Growth Fund" is focused on stocks that the fund manager believes will show substantial growth in earnings.  Whereas, "a Value Fund" owns stocks that the fund manager thinks are "undervalued" or those that he/she believes are able to be purchased at a stock price well below the fair value, and which will be proven out in the next few earnings reports, thereby driving the stock price up, and therefore the overall value of the fund.

See 10 types of mutual funds, defined below:

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Types of Mutual Funds:
1.  Open-ended funds
  The common meaning for "mutual fund" is what is classified as an "Open-ended Fund" by the SEC. "Open-ended" simply means that, at the end of every day, the fund settles its buy and sell orders. That is, at the market close, the open-ended fund issues new shares to investors who put in buy orders that day, and buys back shares from investors that indicated they wished to sell that day.

In this way, an open-ended fund is not traded in real-time many times a day at various prices, but only once daily at a single price, the closing price that day.

Unlike an open-ended fund, a "closed-end fund" is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO). Although the names are similar, a closed-end fund is nothing like a conventional, open-end mutual fund.

2.  Exchange-traded funds (also known as ETFs)
  An exchange-traded fund, or ETF, is a fund that tracks an index, commodity or a basket of stocks like an index fund, but trades actively like a regular stock.  Most ETFs are index funds and track stock market indexes. Exchange-traded funds are also a valuable tool to foreign investors who, for regulatory reasons, are restricted form participating in traditional U.S. mutual funds.

ETFs are securities traded like other stocks and their price fluctuates through the day as they are bought and sold.

3.  Equity funds
  The most simple mutual fund, an equity (or stock) fund is one that trades primarily in stocks.  Also known as a Stock Fund.

Equity/Stock Funds are usually offered by organizing them by company size (e.g., large-cap or small-cap stock funds) or by geography (e.g., domestic or international stock funds).  Geographic equity funds may be offered broadly by region (e.g., Asian Stock Funds) or by specific countries (e.g., Brazilian Stock Funds).  There are also specialty stock funds that focus more specifically on business sectors such as particular commodities, healthcare, and real estate.

4.  Growth Funds
  Growth funds have a diversified basket of stocks with one goal: large capital gains with little or no dividend payouts, and consist of companies with earnings growth that is above average, and that historically reinvest their earnings into expansion, research and development, and acquisitions.

5.  Value Funds
  Value funds concentrate on stocks that are, well, undervalued.  A Value Fund is a basket of stocks that are said to be under-priced to where they should be in the market, and they are likely those that pay dividends.  The theory behind results expected in value funds is that the market in general is inefficient in the way it delivers actual value versus reported value (e.g., current share price).  Therefore, once the market corrects for these inefficiencies, these value stocks will see their share prices rise to compensate.

6.  Index Funds
  Index funds versus active management of a fund
An index fund manages investments in stocks that are part of a major index such as the Dow Jones Industrial Average or the Nasdaq.  Therefore, these funds are not actively traded for performance; they simply follow the performance of the index to which they are tied.

Since an index fund's stocks do not change frequently, an Index Fund manager makes fewer trades, on average, than his Active Fund (e.g., Stock Fund) manager counterpart.  Therefore, index funds do not incur as many expenses to pay for these transaction costs and broker fees.

7.  Bond Funds
  A bond fund primarily invests in bonds and other debt instruments.  These are usually focused in a certain type of debt, such as corporate, municipal, government or convertible bonds.

Municipal bond funds generally have lower returns, but have tax advantages and lower risk. High-yield bond funds invest in corporate bonds, including high-yield or junk bonds. With the potential for high yield, these bonds also come with greater risk.

8.  Money market Funds
  A Money Market Fund's objective is to maintain a net asset value (NAV) of $1 per share, while also earning interest for its shareholders.

Money Market Funds provide investors with a relatively safer place to invest, while still allowing access to liquidity of their assets, and are considered a more conservative, low-risk/low-return investment.

9.  Fund of Funds
  These are a bit unusual because a "Fund of Funds" (FoF) is based on the investment in a basket of other mutual funds, instead of its own basket of stocks.  This is also sometimes referred to as "multi-fund management."

Important to note is that, if the FoF carries an operating expense, you are essentially paying twice for an expense that is already included in the underlying funds in which it invests, thereby reducing your returns.  To help investors understand this potential for fee duplication, in January 2007, the SEC began requiring that these Fund of Funds disclose an expense line called an "Acquired Fund Fees and Expenses" (AFFE).

10.  Hedge Funds
  A Hedge Fund has a portfolio of stocks and other investing vehicles (e.g., derivatives, options, bonds, etc.) that is very aggressively managed by its fund manager(s) in both domestic and international markets, with the end goal of generating returns that are much higher than average funds will deliver.

Typically, hedge funds are set up as private investment partnerships, charging a management fee of 1% or more, plus a "performance fee" of 20% of the hedge fund's profits.  Investments in hedge funds usually require a very large initial investment, and investors are often required to keep their money in the fund for at least one year, known as "a lock-up period" with no access to cash.

These funds are provided for the mega-rich to attempt higher returns for their money.

The term "hedge fund" is a bit of a misnomer, as it originally started out with the goal of "hedging" against downside risk.  Today's hedge fund embraces greater risk, and aggressive trading, for hopefully greater return.


NEXT:  Benefits of Mutual Funds vs. Individual Stocks >>


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