Types of Mutual Funds

Updated on April 8, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Are The Types of Mutual Funds?

The types of mutual funds are many in the market, including balanced funds, fixed-income funds, etc. A mutual fund is nothing but a financial product that invests in bonds or stocks or both.

Mutual Fund Types

The pool of money for investments is accumulated by the investors and is managed by portfolio managers. Owning units of a Mutual fund is like owning a small slice of your favorite stock like Alphabet (Google) or Facebook. Investors get mutual fund units in the proportion of their investments.

Key Takeaways

  • On the market, there are many different types of mutual funds. Some of them include balanced funds, where money is put in a combination of bonds with fixed income and stocks, and equity funds, where money is invested solely in the stocks of various firms.
  • The first division of mutual fund kinds is based on the activity or inactivity of the fund. How the management seeks to invest money and produce returns for account holders varies across the two investment strategies.
  • An example of a mutual fund that invests in common stocks of companies listed on the stock market is an equity fund. Long-term capital growth is this kind of fund’s main investing goal. Stocks are an asset class with a high risk/high reward ratio.

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Types of Mutual Funds Explained

The types of mutual funds available in the financial services market differ from each other widely. While a balanced fund is where the money is invested in a mix of equity and bonds with fixed income, equity funds are instruments where the money is invested only in the stocks of the different companies. In addition, fixed-income funds involve money invested only in the investment that provides a fixed amount of return, and index funds are where the money is invested in the stocks which correspond with the major market index.

Money market funds, on the other, hand, are instruments, where the money is invested in short-term risk-free securities, funds of funds where the money is invested in other funds, global funds, are where the money is invested in instruments that are located outside of the home country and specialty funds where the money is invested in the specialized mandates.

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Examples

The different types of mutual funds with examples are listed below.

#1 – Active vs. Passive Funds

The first classification of types of mutual funds is done on the basis of whether the fund is active or passive. Both investment approaches differ in how the manager wants to invest money and generate returns for account holders. Active funds seek to outperform a specific benchmark it has set for themselves, such as the S&P 500 or BSE Sensex. To achieve this, active funds buy and sell stocks, and managers pay attention to factors like the economy, political situations, and other trends. He also does research around stock-specific factors like ratio analysis, earnings growth, cash flow available to shareholders, and future financial projections, etc.

Passive funds, on the other hand, try to mimic the holdings of a particular index to create similar returns. The manager buys index stocks and applies the same weighting. The objective here is not to beat the index but to remain closer to it. Since index funds require less research and other operational activities, the cost of buying it is less than an active fund.

In the United States, Vanguard, Blackrock, etc. primarily offer only passive funds like Index funds and ETF’s. On the other hand, Fidelity, T Rowe Price, etc. offer many suits of active funds.

In the last five years, passive funds saw a lot of inflows, and their assets under management increased many fold on account of lower fees and better performance than active funds.

mutual-funds-risk-vs-returns

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#2 – Equity Fund

Equity Funds are a type of mutual fund investing in common stocks of companies listed on the stock market. The primary investment objective of this class of funds is long-term capital growth. Equities are at high risk, high reward asset class. They can be best suited to people with high risk-taking ability and looking for higher returns.

t-rowe-stock-market-fund

source: T.Rowe

There are multiple types of equity funds being offered

  1. Sector funds– Most risky of the lot, these funds invest in a particular sector in the economy e.g., IT sector funds will invest in technology companies only.
  2. Region or Country funds– The manager invests money in a particular region such as Asia, Latin America, or Europe, or in a specific country like the United States, India, or China. This is a slightly lower-risk fund than a sector fund.
  3. Large, Mid & Small Cap funds– The investment objective is to invest in particular market capitalization companies such as large-cap funds will invest in blue chip stocks only, while the small-cap fund will invest in stocks with say less than $1 billion market cap. The riskiness decreases with an increase in market cap.
  4. Diversified Funds– Less risky as an investment, it is spread across sectors, regions, countries, and market caps. The manager of this fund requires more skills and knowledge than any other above mentioned types. So selecting the right fund could be challenging. I will try to explain it to readers in the “how to choose a Mutual fund” section.

#3 – Fixed Income Funds (FI)

This type of mutual fund is a bond or debt fund that is a less risky option of investing than in equity funds. The primary objective is to provide steady cash flow to investors. Investment happens in government and corporate debt securities.

t-rowe-fixed-income-funds

source: T. Rowe

These are more suitable for people with risk aversion or reaching their retirement age etc.

  1. High Yield funds– Carries the highest risk of FI funds due to their investment in junk bonds. Junk bonds are the lowest-rated bonds (BB or below) by credit rating agencies such as S&P or Moody’s. It provides more attractive returns than most other fund types in this group.
  2. Corporate Bond funds– Companies borrow money at a fixed interest/coupon rate. The mutual fund manager invests in these securities and receives steady cash payments.
  3. Government Bond Funds or Gilts– Lower-risk funds in this group. Invests in government securities like treasury bonds, notes or gilts, etc.
  4. Money Market Fund- Lowest risk funds that invest mostly in T-bills. A return will be less than other types of FI funds, but the risk of losing the money is also negligible.

#4 – Balanced Funds

These types of mutual funds are known as hybrid funds. The portfolio holds both equity and debt securities. The primary objective is to gain a capital appreciation and generate income for investors. A typical balanced fund invests 60% in equity and 40% in fixed income.

t-rowe-balanced-fund

#5 – Alternative Funds

These types of mutual funds are a non-conventional investment vehicle, unlike stocks and bonds. High net worth and institutional investors are predominantly using this MF type. Due to its complex nature, individual investors are not advised to sign-up for these funds. Alternative Investments funds invest in real estate, commodities, derivatives, and futures contracts, and also in hedge funds.

Frequently Asked Questions (FAQs)

What class of mutual funds are secure?

The least risky large-cap funds invest in large-cap company stocks, which are considered safer than mid-cap and smaller company stocks. Large-cap company stocks are those of well-established corporations with solid financials.

Can new investors buy mutual funds?

Mutual funds are an excellent choice for both novice and seasoned investors. Mutual funds’ benefits of diversity will benefit both sorts of investors, and knowledgeable investors can select funds that focus on particular sectors they believe are set for growth.

What are the risks associated with mutual funds?

Mutual funds are subject to various risks, including market risk (fluctuations in securities’ values), credit risk (default of bond issuers), interest rate risk (changes in interest rates), and liquidity risk (difficulty in buying or selling securities). It’s important to carefully review a fund’s prospectus and consider the risks associated with the underlying investments.

This has been a guide to what are the Types of Mutual Funds. Here we explain the concept with classification along with examples. You may also learn more about Mutual Funds from the articles below –

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