What Are the Types of Mutual Funds, and Which Should I Invest In?

Mutual funds are an easier way to invest. The hard part is picking one.

Mutual funds are a great way to start investing JohnKwan / Shutterstock

If you’re new to investing, you may not want to jump right in and buy individual stocks. It takes a lot of know-how to pick winners and losers, and even wise decisions can end poorly.

There's a more balanced, less risky way to get started.

A mutual fund is a group of investments bundled together. These package deals are overseen by fund managers, who pool your money with other investors’ cash to buy a selection of stocks, bonds and other assets to build a portfolio. Instead of going all-in on one or two stocks, investing in a mutual fund means your portfolio is diversified from the get-go.

The difficult part is choosing one of the thousands of funds on the market. Not only do you need to pick a successful fund, you need to choose from among several different varieties.

Here's how to pick the best one for your investing goals.

Equity funds

Equity mutual funds invest your money in a business or corporation
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Equity mutual funds invest your money in growing companies.

When you invest in an equity fund, your money will go primarily into stocks of publicly traded companies. As a result, equity funds act more like stocks: They have a higher potential for growth but more risk. Equity funds can be a good choice if you're young, as you have more time to recover from a sudden downturn.

You'll often hear them described by the size of the companies they invest in. The key term here is "cap," for market capitalization — the total value of all the company's outstanding shares.

Funds might be labeled:

  • Nano-cap if the companies' shares are worth less than $50 million
  • Micro-cap if the companies’ shares are worth between $50 million and $300 million
  • Small-cap if the companies’ shares are worth between $300 million and $2 billion
  • Mid-cap the companies’ shares are worth between $2 billion and $10 billion
  • Large-cap the companies’ shares are worth more than $10 billion

Smaller companies tend to be more vulnerable and less "proven" entities, so they're often considered riskier investments.

Types of equity funds

Equity funds are also classified based on the kinds of investment strategies they use.

Growth funds invest in companies that are growing very fast. Your fund managers will aim to sell those stocks for more money than they bought them for. All this buying and selling means growth funds tend to come with higher fees. They can make investors more money, sometimes pretty quickly, but are vulnerable to poor bets and the whims of the market.

Value funds invest in stocks and other securities your fund managers believe are currently undervalued. In essence, they're bargain hunting. These funds hold on to companies for a long time, hoping they grow in value and give investors bigger and more reliable dividends. With this stability come lower fees and less risk.

Fixed-income funds

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Fixed-income funds try to pay you in regular installments.

On the other side of the spectrum from equity funds are fixed-income funds. As the name suggests, these funds invest in securities that will pay you and your fellow investors on a consistent basis.

Fixed-income funds try to provide you stable, passive income — not a big windfall. They're a good choice if you're nearing retirement and can't afford to have your portfolio plummet in the next few years.

Types of fixed-income funds

Bond funds don’t invest in company stock but in government and corporate debt. A bond is essentially a loan, with you collecting the interest. The rate of return usually isn't stellar, but it's better than leaving your money in your bank account.

You can also find funds that focus on specific types of debt, like municipal bond funds, corporate bond funds, mortgage funds and foreign bond funds.

Another big category, money market funds invest in reliable short-term debt, like U.S. Treasury bonds or certificates of deposit. They aim to be some of the safest investments around.

Meanwhile, high-yield or "junk" bond funds pick up debt from borrowers who are at risk of defaulting on their loans. You'll get more money in interest for accepting the danger.

Hybrid funds

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Balanced funds try to create a portfolio with a mix of growth potential and stable income.

If you don't want to go hard on any of these strategies, that's OK too. There's a middle ground.

Blended funds are equity funds that go for a mix of growth and value stocks. If you want reliable payouts too, growth-and-income funds and equity-income funds target strong stocks that also give good dividends.

Balanced funds — also called asset allocation funds — try to create a portfolio with a mix of growth potential and stable income. They tend to have a fixed ratio: For example, a balanced fund might keep 60% of your money in stocks and 40% in bonds.

One popular type of balanced fund is called a target-date fund. Your portfolio will gradually shift from an emphasis on growth with stocks to stability with bonds as you near retirement.

Index funds

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Some people don't want to fight to beat the market. Some people just want to keep up.

Index funds create a portfolio that mimics a financial market index. For example, you've probably heard of the S&P 500, which is an index that tracks the stock performance of 500 large companies in the U.S.

Fund managers try to match the performance of an index by purchasing stocks in the companies listed in it — at least a wide range of them. This way, if that particular index is performing well, your portfolio will, too. Because the listed companies don't change all that often, index funds have low operating costs.

If you like the sound of index funds, be sure to check out exchange-traded funds (ETFs), which are similar but can be easier to get into.

Choosing the scope

Industry funds invest in one specific industry, such as natural gas (seen here)
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Industry funds invest in one specific industry, such as natural resources.

Once you've decided how you want your money invested, you also have control over where.

Domestic mutual funds offer both investors and managers a sense of familiarity, though your fortunes will be tied to a single country. International funds invest in companies that do business outside America, while global funds invest in companies that operate both in the U.S. and elsewhere. Emerging market funds focus on investing in countries with small but promising economies.

Industry or sector funds invest in companies within a specific industry, such as natural resouces, technology or health care. They're more appealing to experienced investors; you might choose a sector fund if you predict a boom in that area or to fill a hole in your portfolio.

How to pick the right mutual fund

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You may want to invest in more than one mutual fund to hedge your bets even further.

To narrow down your options, consider your age, how much risk you’re willing to accept and whether you’d prefer a quicker return on your investment or regular payouts. If you’re early in your career, you have more time and more earning potential ahead of you and may be able to handle more risky investments. Investors nearing retirement may prefer more stability and security.

Remember, there's nothing stopping you from investing in more than one mutual fund to hedge your bets even further. No fund is perfect.

And finally, you don’t have to do this alone. Especially when you're just getting started, it's a smart idea to get help from experts. The team at Facet Wealth is a great option; its certified financial planners are easy to reach online, bound by law to do what's best for you and have custom plans for millennials, young families and retirees.

Don't be paralyzed by choice. Mutual funds are supposed to be the easier, safer approach to investing — so do some research, make a move and start growing your wealth.