Types of Funds and Features
While the core features of mutual funds are the same, their investment objectives can be very different. Because each mutual fund has a specific investment objective, such as growth, capital preservation, or income, it is important to understand which funds are designed to meet your investment objectives. Mutual funds generally fall into these main categories:
Stock or Equity Funds invest in the ownership of companies through
Bond or Fixed-Income Funds invest in government or corporate
debt to generate income.
Money Market Funds invest in short-term debt, pay interest and
target a stable share price.
Asset Allocation Funds invest in a mix of stocks, bonds, alternatives
and money market securities.
Alternative Funds do not invest in conventional securities such as stocks, bonds and cash. Rather, they invest in private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.
Alternative strategies on traditional asset
classes include long and short equities as
investment strategies. This involves buying long equities expecting to increase
in value and selling short equities expected to decrease.
Mutual funds are the most common way people invest for the future with more than $20 trillion in investment assets. They are so popular because they are a simple, convenient way to invest in stocks, bonds, money markets, commodities and other securities. Through mutual funds, almost anyone can invest in the financial markets as a means to meet financial goals. Nearly half of all U.S. households invest in mutual funds.
These professionally managed investment products use money from investors to create a diversified pool of securities to achieve a specific investment objective. Investors purchase shares, which represent ownership in the mutual fund. The price of the fund fluctuates based on the gain or loss of the securities that make up the fund. Investors in a mutual fund are entitled to a pro-rata share of the proceeds, or the losses.
Exchange Traded Funds
An exchange traded fund is a type of security that is similar to an index mutual fund, because it tracks an index, commodity or a grouping of assets. But unlike a mutual fund, it can be traded like a stock on an exchange, with prices changing as shares are bought and sold.
With an ETF, you get the diversification of a mutual fund as well as the ability to sell short, buy on margin and purchase as little as one share. As a general rule, expense ratios for ETF’s are lower than the average mutual fund. You have to pay a commission to purchase an ETF through a broker.
One of the best known ETFs is called the Spider (SPDR), which tracks the S&P 500 Index and trades under the symbol Spy.
Closed-end funds sell a fixed number of shares to investors during an initial public offering (IPO). This differs from open-end mutual funds which continually offer shares to investors. Since the issuance of new shares is closed to investors after the IPO, trading occurs on an exchange like the NASDAQ or NYSE, and investors can buy and sell shares of a fund as they would stocks. As a result, the demand for a particular closed-end fund may be greater or less than the actual value of the securities it owns, causing it to trade at a premium or discount.
Closed-end funds are actively managed and generally designed to provide a steady stream of income that pays out monthly or quarterly. Because of their unique closed-end structure and ability to use leverage, which also increases a fund’s risk or volatility, many closed-end funds offer shareholders the potential for higher distributions than traditional income investments.