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 have different levels of interest rate sensitivity depending on whether they focus their investments on short, intermediate, or long-term bonds.
Municipal bond funds invest in municipal bonds issued by various state and local governments. These bonds are often used to finance capital projects, such as building schools, highways or sewer systems, and to fund day-to-day obligations. In addition to providing a source of income and diversification, the interest income on municipal bonds generally is exempt from federal income tax and may also be exempt from state and local taxes for residents in the state where the bond is issued.
Asset allocation funds invest in different mixes of securities, which vary depending on the fund's 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.
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.
Commodity 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.
Alternative mutual funds tend to invest in non-traditional investments and often use complex investment and trading strategies. For example, they may invest in real estate, managed futures, derivatives, currencies, options as well as traditional investment types such as stocks, bonds and cash. Alternative funds have a wide range of investment objectives and may use complex and more investment strategies such as short-selling or tactical asset allocation. Investors considering alternative funds should be aware of their unique characteristics and potential risks. When researching these funds investors should carefully read through the investment objective, management approach, fees and performance history.
