The playlist of the investment world, funds can give you easy access to a precrafted greatest hits of investments. Here's everything you need to know about different types of funds.
A fund is simply a collection of money earmarked for a specific goal. Even if you've never invested a dollar before, you're probably familiar with the concept: You might have a jar where you stash a rainy-day fund or a separate savings account where you're building a fund to replace your roof or upgrade your computer.
What's key in any case is that the dollars you save have a clear purpose. When that purpose is potentially growing more money, many people turn to a particular type of fund: the investment fund.
How does a fund work?
Investment funds provide investors with a professionally managed portfolio of investments that may help investors grow their money over time. They're often started when investors pool their money together to buy more kinds of investments than they could on their own. The investors then receive a number of shares in the fund reflecting how much they contributed. The shares' value may go up and down based on a variety of factors, including the behavior of other shareholders and the value of the investments in the fund. Similar to other investments, shares of the investment fund can be redeemed for cash by the investor.
Fund components can include a range of investments but are generally stocks and bonds.
Types of funds
There are many different types of investment funds, but some of the most common include:
Traditional mutual funds One of the original types of funds the average investor could invest in, traditional mutual funds let you buy shares of a portfolio of investments, which typically contains stocks, bonds, or a mix of both. Many traditional mutual funds are actively managed, meaning professional portfolio managers research and carefully select all of the investments and may adjust fund holdings in response to real-time trends or events.
Some, however, are managed passively: A portfolio manager simply picks investments based on what is tracked in a benchmark index, such as the S&P 500®,1 a grouping of 500 of the biggest companies in America. Passively managed funds don't normally change their holdings unless the components of the index itself change. Notably, traditional mutual funds trade only once per day, after trading on the major stock exchanges has stopped.
Exchange-traded funds (ETFs) By and large, ETFs are similar to traditional mutual funds. Each lets you buy shares that provide exposure to a diversified mix of primarily stocks and bonds. Like traditional mutual funds, ETFs can be actively or passively managed. One of the differences is that unlike traditional mutual funds, ETFs trade throughout the day like stocks.
Index funds Index funds are passively managed ETFs or traditional mutual funds that simply seek to replicate the performance of major stock market indexes. In addition to the S&P 500®, common indexes include the Dow Jones Industrial Average®,2 Nasdaq Composite®,3 and Russell 2000®.4 Index funds may be aligned to the US stock market at large, specific sectors of the stock market, stocks in different countries, and even bond indexes.
Target date and target allocation funds As their name implies, target date and target allocation funds are mutual funds that have a target in mind.
Target date funds provide a single-fund option for retirement investing. You simply pick a fund whose target year matches when you want to retire and contribute money to it. Then the fund manager updates the fund's asset allocation over time so that they're more aggressive during accumulation years and more conservative when the fund reaches its target date and beyond.
Target allocation funds, meanwhile, strive to keep a certain percentage mix of different investments, such as 80% stocks and 20% bonds. They shift their holdings based on market conditions to keep the fund's target split.
Advantages of funds
Convenience With investment funds, you don't have to worry about conducting extensive, granular investment-level research yourself or choosing the most opportune time to buy shares of a particular company. Instead, you're turning to the expertise of fund management professionals—or even simply the market itself, in the case of index funds. What's more, products such as target date funds allow you to easily invest in a whole professionally managed portfolio of investments in one place.
Diversification When you invest in individual stocks, you concentrate your dollars in a handful of companies, which can raise the risk that you lose the money you invest. By buying into a fund, though, you're instantly gaining exposure to tens or perhaps hundreds of companies or bonds. This may lower the risk that any poor-performing investment brings down your entire portfolio's value.
The bottom line on funds
While buying funds may make investing safer and easier, you still have to do your due diligence: Each fund has its own set of objectives, investment strategies, expenses, and risks. You'll want to make sure the funds you select align with your financial goals, willingness to take on risk, and investing timeline.