INVESTMENTS  -  MUTUAL FUND CATEGORIES
 
 

Mutual Fund Glossary

Stock Funds

A stock (or equity) mutual fund invests its money in stocks of individual companies, large and small, new and old, here and abroad. There are many different types of stock funds, characterized both by the kind of companies in which the fund invests, and by the fund's particular objective. Here are the main categories of stock mutual funds:
 

Growth funds. These funds seek capital gains from companies that have the potential for steady growth in earnings. Growth funds aim to achieve a rate of growth that beats inflation without taking the risks necessary to achieve occasional spectacular success. A riskier type of stock fund is aggressive growth funds. These attempt to achieve very high returns by investing in more speculative stocks, maximizing capital gains income. Since the growth stocks favored by growth funds and aggressive growth funds pay little or no dividends, neither do these funds distribute much, if any, dividends.

Growth and income funds. These seek a more balanced stock portfolio that will achieve capital appreciation as well as current income from dividends. These funds are less risky than growth funds, because the dividend may offset at least some of the periodic losses in stock prices. In times of high market volatility - in either an up or a down direction - growth and income funds generally don't rise and fall as much as growth funds.

International funds. These have been attracting investors' attention because foreign stock markets have pretty consistently outperformed the U.S. stock market. Moreover, there are many excellent companies that trade only on foreign stock exchanges. Therefore, international funds provide additional diversification to a portfolio. Most international funds invest throughout the world. Some invest only in one country or region. Global stock funds, however, differ only in that they also invest in U.S. securities.

A bond mutual fund invests its money in bonds of companies or governments that are as varied as those in which the stock funds invest. Bond funds tend to be the more conservative growth- and income-producing portion of an investor's portfolio - although bond fund share prices can and do fluctuate in value. Some bond funds even deliver tax-free income to their investors.
 

Government bond funds. Backed by the full faith and credit of the U.S. government, these offer total protection from bond default, although the value of government bonds will fluctuate with interest rates like all bonds and bond funds. Most government bond funds hold at least some U.S. Treasury securities (whose interest is exempt from state income taxes unless you hold the fund in a retirement account). One variety of government bond fund, government mortgage funds, holds mortgage-backed securities such as those issued by the Government National Mortgage Association (GNMA). Holders of GNMA funds receive both interest income and a partial return of principal, which may be reinvested.

 Municipal bond funds. These provide investors with a means for tax-free income. Since municipal bond fund prices do not appear in the daily papers and are inconvenient for the individual investor to manage, muni bond funds are a useful way to invest in municipal bonds while avoiding these problems. Interest earned from bonds not issued in the investor's own state is fully taxable in her own state, so in order to produce maximum tax-free income, single state funds have been developed that hold municipal bonds from only one state. A California resident owning a California muni fund, for example, will avoid state as well as federal taxes on the fund's interest income. Most municipal bond funds invest in higher-rated municipal securities. High-yield municipal bond funds, however, invest in lower rated municipal bonds (yes, municipal bonds can default), and are appropriate for investors seeking high interest income who are willing to accept higher risk. Incidentally, high-yield municipal bond funds and high-yield corporate bond funds (discussed below) are, in less polite company, called "junk bond funds."

Corporate bond funds. As the name so amply suggests, these buy and trade bonds of corporations. There are two categories of corporate bond mutual funds: Investment-grade corporate bond funds, which are comprised of higher-quality corporate bonds and seek high income with limited risk, and high-yield corporate bond funds, which invest in lower-rated corporate bonds.

 
Bond funds come in different maturities. m sorry to complicate matters a bit more, but this is one situation where complexity begets better investment opportunity. Bond mutual funds are not only categorized according to the type of bonds that the fund will invest in as discussed above - municipals, governments, and corporates. But they are also divided up according to the approximate length of maturity of the bonds that the manager puts into the portfolio. There are three maturity levels:
 

Short-term bond funds (also called limited-term bond funds). These funds in bonds with an average maturity of between one and four years.

 Intermediate-term bond funds. These funds invest primarily in intermediate-term bonds with an average maturity of between four and ten years.

Long-term bond funds. These funds usually invest primarily in bonds with an average maturity of greater than ten years.

 
I suggest that you invest your bond money in funds with varying maturities. In other words, some of the money will go into a short- or intermediate-term bond fund and some will go into a long-term bond fund. There is method in my madness, however. One of the most widely-accepted strategies for investing in bonds is called "laddering maturities." Rather than putting all of your money into a single maturity bond fund - be it short, intermediate, or long - laddering maturities means investing in mutual funds (or individual bonds for that matter) with a variety of maturities. By owning bonds with varying maturities, you reduce somewhat the risk of losing a lot of principal because of a change in interest rates. For example, if you have all of your bond money in long-term bonds and interest rates rise, you could stand to lose quite a bit of principal value. That"s because the longer the maturity of a bond or bond fund, the more the principal changes (both downward and upward) in reaction to a change in interest rates. On the other hand, if you had laddered your maturities by owning some short- and/or intermediate-term bond funds as well, you wouldn't have been hit as badly as a result of a rise in interest rates.

Specialized Funds

Specialized funds offer mutual fund investors even more choice.  But be careful - the more specialized a fund becomes, the riskier it can be.
 

Balanced funds. These maintain a "balanced" combination of common stocks, bonds, and perhaps preferred stocks. They provide diversification between stocks and bonds in the same fund with a low minimum investment and are thus a good investment for someone with a small amount to invest.

 
One of the advantages of balanced funds and a major reason they have done so well as long-term investments is the forced discipline that they impose on the fund manager. As stock prices rise, the fund manager is forced to sell stocks to bring the portfolio back into balance. Conversely, if stock prices decline, the fund manager will be purchasing stock to bring the fund back into balance. Thus, the manager is forced to "buy low" and "sell high." Would that all of us could enforce that discipline upon our investments! Actually, I hope you will. Balanced funds are the one fund to own if you own only one fund. (They're a great IRA investment, too.)

 Sector funds. These invest only in the stocks of a single industry, such a biotechnology, waste management, utilities, or energy. Sector funds, unlike the typical mutual fund, zero in on a particular industry that may or may not have attractive prospects. The lack of diversity across industries means that sector funds can rapidly change from excellent to abysmal performance. Sector funds behave more like individual stocks than diversified funds, and selection of a sector fund cannot be made by using the same criteria (such as past track record) that usually guide the purchase of funds.

 
Don't be surprised if you see sector funds dominating the list of high-performing mutual funds over the past quarter or year. But before rushing to make an investment, realize that you'll probably find this fund ranked among the worst performers a year later. That's the way sector funds work.

It's a Matter of Style

Within each of the stock fund categories - growth, growth and income, small company, and international - fund managers adopt one of three "management styles:"

Growth - Managers who favor growth investing choose companies whose revenues and earnings are accelerating. These companies are often the best performers in strong bull markets.

Value - Managers of value funds favor companies whose stocks are undervalued. Perhaps the companies are temporarily out of favor with Wall Street or they possess unusually valuable, but as yet unrecognized assets. Value stocks usually don't perform as well as growth stocks in rapidly rising markets, but they also don't fall as much in declining markets.

Blend - Finally, some managers prefer to find investment opportunities wherever they lurk, so they will use a blend of both growth investing and value investing.

When evaluating funds for possible addition to your portfolio, be sure to find out the fund manager's investment style. The easiest way to find out is to check one of the mutual fund monitoring services at the library. Aggressive investors tend to favor funds that utilize the growth style, more conservative investors prefer value funds, and, finally, some prefer managers who mix it up. Finally, investors who want to hedge their bets may select one growth-style fund and value-style fund in each stock fund category.