For virtually every investing goal and every appetite for risk there is an appropriate type of mutual fund. While every fund involves some level of risk, that risk varies based on the type of fund in which you invest. Understanding the risks involved with investing and your own tolerance for risk—as well as your desire to involve yourself in the management of your investments—is key to helping you choose the fund or funds that best meet your investing needs.
Money market funds invest in highly liquid, short-term securities, such as Treasury bills and certificates of deposit. These are considered to be some of the lowest-risk funds available.
Bond funds are professionally managed portfolios that invest in numerous individual bonds. Each fund has a stated objective, generally focusing on a particular sector, such as corporate or Treasury bonds, or broad category, such as investment grade or high yield. Funds can also be managed to a specific time horizon, investing only in short, intermediate, or long-term bonds.
Asset allocation funds invest in different mixes of securities, which vary depending on the funds’ goal. Funds such as target date funds, adjust their asset allocation over time while others, like target allocation funds, maintain a fixed asset allocation. Many investors use income replacement funds to help create an income stream in retirement. There are also income and real return strategies which are managed to help take advantage of certain outcomes, and world allocation funds which give fund managers the flexibility to seek opportunities anywhere in the world.
Domestic stock funds invest in stocks issued by U.S. companies. Many of these funds specialize in companies of various sizes, while others focus on either growth stocks or value stocks.
Index funds are the only funds that are not actively managed. Instead, they purchase most or all of the securities contained in a specific index with the intention of delivering the same performance as that index. There are different types of index funds—domestic stock, international stock, and bond—each of which offers different levels of risk.
Sector funds focus on one particular segment of the economy and invest in securities issued by companies concentrated in that segment.
International and global stock funds invest in stocks issued by companies located throughout the world, including, potentially, U.S. stocks. Some of these funds invest in companies located in emerging market countries and that can add an element of risk to those funds.
Real estate funds invest in companies that are tied to the commercial and residential real estate markets which could include mortgage companies, property managers, realtors, and builders. The companies held within the real estate funds are highly concentrated in a single industry so the funds tend to be riskier than other stock funds.
Commodity focused stock funds don’t invest directly in commodities, but they do invest in companies that are involved in commodity-intensive industries, such as energy exploration or mining. As a result, their performance can loosely track the performance of certain commodities. While these funds can be a great hedge against inflation, they can also be much more volatile than most stock funds.
Market neutral funds can maintain long and short positions in search of consistent returns approximately 3% to 6% above three-month Treasury bill yields, regardless of what direction the overall market moves. The positions in these funds can be in many different types of securities, including domestic and international stocks, ETFs, bonds, currencies, and commodities.
Inverse/leveraged funds are suitable for sophisticated investors willing to absorb potentially significant losses. . Inverse funds seek to increase in value when the market declines and decrease when the market rises, which is the opposite of traditional mutual funds. They are often used to profit from or hedge exposure to downward-moving markets. Leveraged funds seek to amplify the returns of a specific benchmark. Some funds are both inverse and leveraged, in that that they seek to achieve a return that is a multiple of the opposite performance of the underlying index or benchmark.