Equity funds

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.

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Fixed-income funds

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

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.

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Index funds

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, or ETFs, which are similar but can be easier to get into.

Choosing the scope

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

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.

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.

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About the Author

Esther Trattner

Esther Trattner

Freelance Contributor

Esther was formerly a freelance contributor to MoneyWise.

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