Mutual funds control a significant portion of US financial assets. Mutual funds offer investment diversification, professional management and convenience to investors. Every mutual fund has an investment objective, which it describes in its prospectus. The fund’s name often reflects its investment objective; for example, a fund that seeks a balance of growth and income might call itself the Growth and Income Fund. Most fund objectives are designed to provide a particular type of return. As a result, the fund objective has a major impact on the types of securities that dominate the fund’s portfolio. The Investment Company Institute classifies mutual funds into various categories according to their objectives.
There are six broader categories of Mutual funds according to their investment objectives: Common Stock Funds (also known as Equity funds, Stock funds), Special purpose funds, Income Funds, Bond Funds, Balanced Funds and Money Market Funds.
Common Stock Funds: In this type of Mutual funds, funds are invested almost entirely in common stock of companies, although their objectives vary considerably. Some of the different types of stock fund are: growth funds, aggressive growth funds, growth and income funds, Income-equity funds and Option income funds.
Growth funds are seeking capital appreciation by selecting companies that should grow more rapidly than the general economy. The primary objective of these funds is capital appreciation rather than current dividend income. Growth funds hold the common stocks of more established, large growth-type companies. Aggressive growth funds invest in small or more speculative growth companies for maximum capital appreciation. The primary investment objective of these funds is capital appreciation, however, the investment policies tend to be more aggressive and riskier that for growth funds. These funds may hold common stocks in startup companies, new industries, and regular growth-type stocks. Growth and income funds seek long-term capital appreciation with income. Funds are invested in common stocks of well-established companies that are expected to show reasonable growth of principal. Their risk level is moderate. Index funds, a popular type in recent years, buy representative stocks to simply match the market indices. Income-equity funds (Dividend Yield funds) tend to invest in common stocks of companies with stable and good dividend returns. The emphasis is on secure and reasonable dividend yields and not on capital appreciation. Investment in this type of funds carries relatively low risk. Option-income funds invest in common stocks of companies to seek maximum current return by writing call options on the stock they hold. Option income funds sell option contracts against the stocks they buy. Large Cap funds invest in stocks of large companies, such as General Motors, and General Electrics which have strong business background, large market and lower business risk. Small Cap funds invests in stocks of smaller companies. Smaller firms have comparatively greater business risk than larger firms, but they have greater potential for profit.
Sector funds/Special purpose funds: Funds in this category have objective or limit their investment to a specialized industry or sector such as energy-related firms or companies that produce precious metals. These fund permits investors to concentrate on a specific investment segment. These funds can also use futures and options and short selling to meet more aggressive objectives.
Income Funds: Income funds are portfolios consisting of bonds and common stocks as well as preferred stocks. Income fund managers try to obtain satisfactory interest and dividend income for the shareholders.
Bond Funds: Bond funds seek high income and preservation of capital by investing primarily in bonds and selecting the proper mix between short term, intermediate-term, and long-term maturities. A bond fund may restrict its investments to certain categories of bonds, such as corporate, municipal, or foreign bonds. In recent years, tax-free municipal bonds funds have been popular.
Balanced Funds: Unlike most of mutual funds that make investment exclusively in one asset class, balanced funds invests a portion of its assets into each of major asset classes: cash and cash equivalents, government securities, corporate bonds, and corporate stocks. Main object behind is that if one asset class were to fall in value, another would rise to compensate, thus giving investor a balanced rate of return.
Money Market Funds: Money market funds are a special form of mutual funds. Main investment objective of these funds is to provide more safety of principal or investment. The investor can own a portfolio of high yielding CDs, T-bills, and other similar securities of short-term nature, with a small amount to invest. Their investment portfolio covers investment in short-term government securities, commercial papers, and certificates of deposit. Each share has a net asset value of $1, however, yield fluctuates daily.