Getting mutual fund investing right is not simply a question of deciding that this is a good investment solution. There are many different types of mutual funds and individual investors may see better results if they consider which options will suit them best. This may be particularly important for those building retirement savings.
Primary Types of Mutual Funds: Money Markets, Bonds and Stocks
The three core areas of mutual fund investment are money markets, bonds and stocks. Each of these options invests in different areas, gives different options for income or growth and comes with different potential for return and risk.
- Money market mutual funds: These products tend to work on a shorter-term income basis and invest in government and corporation instruments, such as securities, CDs, bank notes or commercial paper. Returns may be lower than with other types of funds but the risk factor is also reduced which suits some investors.
- Bond mutual funds: The investment here is made into bonds usually based on government, federal agency or corporate debt. Income returns may be higher than with money market funds but the risk involved also increases depending on the product that is selected.
- Stock/equity mutual funds: These products invest in stocks and are focused on growth. Investment could be targeted at sector, company size, or index. Other options include growth potential, risk, regional, international, socially responsible or specialty areas. Historically, equity investment has shown the best returns over time. This is, however, also the highest risk product.
In addition to mutual funds with a focus on a specific asset class, investors also have the option of choosing a product that mixes investments to balance risk and return.
What are Balanced and Asset Allocation Mutual Funds?
Some funds offer mixed investment types that can help balance risk and return as well as income and growth. So, for example, a portfolio may combine stocks, bonds and money market elements. This suits many investors who want to see higher returns than may be given by safer funds but that also want to try to minimize risk by not solely investing in equity or bond markets.
A balanced fund often has a specific percentage split between types of funds. An asset allocation product may not impose set limits on each kind of investment and may switch investments around according to market conditions or other markers. Mutual funds targeted at retirement, for example, may weight risk during early years and emphasize safety later. These funds are often known as target date or age-based funds.
Choosing the Best Mutual Fund Investing Strategy
With so many different types of mutual funds to choose from, it can be difficult to settle on the best option. Using risk and return measures may work well for some investors and life stage/target financial needs may also play a part in the decision-making process. So, for example, an individual that is investing for retirement on a long-term basis may have different needs to someone that is looking for a shorter term return.
It is also important to learn as much as possible about the implications of choosing this kind of investment strategy before taking this step. It may, therefore, be useful to learn more how mutual funds work to check that this is an appropriate solution. Those that decide to proceed may also find that a fund calculator helps to compare cost and performance during the short-listing process.
Sources: U.S. Securities and Exchange Commission ("Invest Wisely: An Introduction to Mutual Funds"); Investopedia ("Mutual Funds")
Carol Finch - Carol Finch is the Topic Editor for Retirement Planning, Budgeting, E-Commerce & Technical/Business Writing on Suite101.
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