There are thousands of mutual funds in the investment universe but they can be divided into a few basic types and categories of funds. The two primary types of mutual funds are stock funds and bond funds. From there, the categories of funds get more specialized and diverse.
For example, stock funds can be further broken into three sub-categories of capitalization — small-cap, mid-cap, and large-cap. They are then categorized further as either growth, value, or growth and income. Stocks can also be classified as international, global or foreign, all of which have similar objectives.
Bond funds are primarily categorized by the duration of the bonds, which are described as short-term, intermediate-term, or long-term. They are then broken into sub-categories of corporate bonds, municipal bonds, and U.S. Treasury bonds.
Most mutual fund categories can be purchased as index funds, which can be described as passively-managed funds. This means that the portfolio manager does not actively buy and sell securities but rather matches the holdings of a benchmark index, such as the S&P 500 index or the Dow Jones Industrial Average. Beginners often start with one of the best S&P 500 Index funds.
From there, investors can learn more about the various types of mutual funds, such as those mentioned here, and how to build a portfolio of mutual fundsaround that core investment. Index funds often have hundreds of holdings and offer investors the greatest features of mutual funds — simplicity, diversity and low-cost.
Understanding the Risks of Investing in Mutual Funds
Stocks, bonds, and mutual funds all involve some level of market risk, which is the possibility of fluctuation in value or even the loss of principal (the amount you originally invested).
For example, you could invest $1,000 for 10 years and end up with $950. Although receiving a negative return like this over a 10-year period is extremely rare, it is possible. It is more reasonable to expect an average of return of somewhere between 7 and 10 percent for stock investments, including stock mutual funds, for periods of 10 years or more. However, there are short periods, such as 1 year, where your stock mutual fund can decline in value by as much as 30 to 40 percent. Similarly, you could have gains of more than 50% in one year.
So whether you’re investing in individual stocks or a stock mutual fund, you need to have some reasonable expectations about how the stock marketbehaves. And more importantly, how you will react in the brief but inevitable extremes? Will you sell your mutual funds if they lose 10% in 3 months? Before you begin investing, it’s best to get an idea of your risk tolerance.
Getting Started Investing in Mutual Funds
If you’re a beginning investor, all you need to do now is identify your investing objective, which might be college savings or retirement, and choose the best funds for you. If you have less than $3,000 to invest, it’s possible that you’ll need to begin your portfolio with one mutual fund. If that’s the case, be sure to read our article on best mutual funds for beginning investors.