Mutual Fund Site

There are many different types of mutual funds from which an investor can chose. The most basic types of mutual funds are outline below, with more discussion available if you follow the appropriate links.

Cash Equivalent Mutual Funds
These types of mutual funds will invest in short-term cash-like securities such as Treasury Bills (90 days or less) and Money Market instruments.

While interest rates are excessively low, it may make little sense for investors to hold money in money market funds because the management fees on such funds will often exceed the rate of return earned on the underlying assets. This then presents a situation where investors are generally ensuring some type of loss on their investments, making alternate cash investments more lucrative (even a 30 term deposit looks mighty attractive in comparison).

Generally speaking, Cash Equivalent mutual funds exist as a way for investors to “park” funds for whatever reason. There is no reasonable expectation for gains or losses, but the belief is that the money invested will be available for withdrawal once they need it.

Bond Funds and Fixed Income Mutual Funds
Fixed Income mutual funds invest in assets that generate some form of income, normally interest income as in the case of Bond Funds (but it could also be dividend income in the case of preferred share-types of income funds). The objective with fixed income mutual funds is to generate income with the investment.

In general, periods of high interest rates are the best time to invest in Bond Funds and other Fixed Income mutual funds. The reason is that high rates are normally a prelude to periods of dropping rates, which is favorable for market prices on bonds and other fixed income securities. This inverse relationship between rates and bond prices is a market all its own, but the primary purpose for holding bond funds is to generate income within one’s portfolio.

Just as there can be tremendous tweaking and specialization within an equity or growth fund, there can also be a tremendous amount of tweaking within a bond fund. This means there are different levels of risk and volatility within this asset class and investors should be prepared for this.

There are several sub-classes of fixed income mutual funds, including High Yield Investments, Government Bond Funds and so on. Another important consideration is what is known as “duration,” which is simply the remaining term to maturity, of the fixed income securities in question. The reason for this is that longer term bond funds are considered more volatile and risky than shorter-term fixed income investments.

Equity Funds
Considered the most exciting asset class, equity funds offer the greatest opportunity for growth and short-term price fluctuations. As a consequence, it is often referred to as the riskiest asset class. Investors who purchase equity funds typically do so with the hope of seeing time-valued growth increase the value of their equity mutual funds, regardless of whether any income is paid and the price fluctuations of the underlying assets.

With the biggest consideration being security price growth, equity funds will invest in riskier assets that will show greater price fluctuations and often have riskier attributes (e.g. equity position, sales trends, management style, etc.) than fixed income securities. Of course, where the risk is taken will depend largely on the type of equity fund in question — value versus growth versus a blend of both.

In addition to investment style classification (growth, value, blend), equity funds also fall into different capitalization categories, including giant cap, large cap, mid cap, small cap and micro cap. Further specialization can be achieved by investing in specific geographic areas, market sectors (industries) and so on.

As you can imagine, constructing an equity fund involves many different considerations and as such represents the greatest opportunity for specialty asset classes.

Balanced Funds
Considered a blend of the three different asset classes outlined above, balanced funds will invest in the above but with different weightings depending on their purpose. For example, target-date balanced funds will theoretically hold more equities and less fixed income and cash assets when there is a greater time period before the target date arrives; and less equities but more fixed income and cash assets as that target date approaches. In other words, balanced funds invest in all three asset classes.

There are generally two different types of balanced funds. The first is a tactical balanced fund that will make investment decisions based on different market signals that suggest whether the investment or portfolio manager should be over- or under-weighted in one particular asset class versus another. This means that an investor who is invested in a tactical balanced fund is entrusting the fund manager to make the appropriate asset allocation decisions.

In comparison, a strategic balanced fund will stick to a specific asset mix (e.g. 75% equities and 25% bonds). Deviation from this asset mix will result in the portfolio being rebalanced. Investors who prefer strategic balance funds will have a firm dedication and commitment to that specific asset mix.

Since balanced funds encompass all three asset classes, they are deemed less risky than equity funds but their variability means they are normally higher priced (not always) than straightforward asset class funds. Higher costs are normally attributed to having to engage more than a single “expert” depending on the size of the balanced fund (e.g. a domestic equity fund requires expertise in domestic equities while a Global Balanced Fund will require expertise in all different global equity markets as well as the different global bond markets, etc..).

Index Funds
Unlike all of the funds listed above, Index Funds aim to mirror the holdings of a specific Index. This takes all investment discretion out of the hands of the portfolio manager and leaves it to the Index creator, such as Standard and Poor’s (e.g. S&P 500) MCSI (e.g. MSCI EAFE), etc..

There are different benefits to holding Index Funds over actively managed funds, namely that on an overall basis the fees are lower (though it will always depend on the fund company, so this is not always true of specific funds) and most actively managed funds struggle or aim to achieve a performance that is equal to or better than the index anyway. In other words, the theory is that many cookie cutter mutual funds will typically own most of the index anyway and simply pick and choose various weightings so that the “winners” of the index carry the fund and the “losers” of the index are minimized or ignored by the fund altogether… so why not simply own the index anyway?

Index funds are often of being simple solutions in that there is less need to think about all of the different options available in the different equity funds or bond funds. However, since there are so many different indexes out there from which a fund or investor can choose, thinking that choosing a simple index fund as an investment solution is fairly inaccurate. In many cases, the decision is equally difficult and not simpler at all (read more about finding the right Index Funds).

With the available choices in mind, astute investors can creatively create their own highly specialized portfolio through the use of index funds rather than relying on actively managed equity funds and bond funds. The benefits could be less security overlap, lower fees and the peace of mind that overall index performance IS the benchmark.